Setting the Right Price

Setting the Right Price
Chapter 20 Setting the Right Price Setting the Right Price Chapter 20 Lamb, Hair, McDaniel © Cengage Learning All Rights Reserved.

© 2015 by Cengage Learning Inc. All Rights Reserved.
Chapter 20 Setting the Right Price 1 Describe the procedure for setting the right price Identify the legal and ethical constraints on pricing decisions Explain how discounts, geographic pricing, and other special pricing tactics can be used to fine-tune the base price Discuss product line pricing Describe the role of pricing during periods of inflation and recession 2 3 4 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Describe the procedure for setting the
Chapter 20 Setting the Right Price How to Set a Price on a Product Describe the procedure for setting the right price 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Exhibit 20.1 New-Product Development Process
Chapter 20 Setting the Right Price Exhibit 20.1 New-Product Development Process Fine-tune with pricing tactics Choose a price strategy Estimate demand, costs, and profits Establish pricing goals Results lead to the right price Notes: Setting the right price is a four-step process as shown in Exhibit 20.1. 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Pricing objectives fall into three categories:
Establish Pricing Goals Chapter 20 Setting the Right Price Pricing objectives fall into three categories: Profit-Oriented Sales-Oriented Status Quo Notes: The first step in setting the right price is to establish pricing goals. In Chapter 19, we learned that pricing objectives fall into three categories—profit oriented, sales oriented, and status quo. These pricing goals are derived from the firm’s overall objectives. A good understanding of the marketplace and of the consumer can tell a manager if a goal is realistic. All pricing objectives have trade-offs. Reaching the desired market share often means sacrificing short-term profit, because without careful management, long-term profit goals may not be met. Meeting the competition is the easiest pricing goal to implement. But demands and costs, the life-cycle stage, and other considerations can not be ignored when creating pricing objectives. 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Choose a Price Strategy
Chapter 20 Setting the Right Price A basic, long-term pricing framework that establishes the initial price for a product and the intended direction for price movements over the product life cycle. Notes: The price strategy sets a competitive price in a specific market segment. Consequently, changing a price strategy can require dramatic alterations in the marketing mix, including the product itself. Pricing a new product depends on the market conditions and the other elements of the marketing mix. For example, introducing a product resembling several others in the marketplace will have restricted pricing freedom. In contrast, introducing a product with no close substitutes will have considerable pricing freedom. Most companies do not do a good job of researching price strategies. 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Choose a Price Strategy
Chapter 20 Setting the Right Price Status Quo Pricing Price Skimming Penetration Pricing Charging a price identical to or very close to the competition’s price. A firm charges a high introductory price, often coupled with heavy promotion. A firm charges a relatively low price for a product initially as a way to reach the mass market. Notes: Companies that plan for creating a price strategy can select from three basic approaches: Price skimming Penetration pricing Status quo pricing 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Price Skimming Situations When Price Skimming Is Successful
Chapter 20 Setting the Right Price Price Skimming Situations When Price Skimming Is Successful Unique Advantages/Superior Legal Protection of Product Blocked Entry to Competitors Technological Breakthrough Inelastic Demand Notes: Price skimming is a pricing policy whereby a firm charges a high introductory price, often coupled with heavy promotion. The term is derived from the phrase “skimming the cream off the top.” Companies often use price skimming for new products when the product is perceived as having unique advantages. Over time the price will be lowered. Additional situations when price skimming is successful are listed on this slide. Luxury retailers often employ a strategy called anchoring, in which one highly priced item makes other items seem less expensive by comparison, though they are still priced as high as the market will bear. Firms often feel it is better to test the market at high prices and then lower the price if sales are too slow. A price skimming strategy will encourage competitors to enter the market. Discussion/Team Activity: List companies and/or products that utilize a price skimming strategy. 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Penetration Pricing Chapter 20 Setting the Right Price Advantages Disadvantages Can lead to lower cost per unit as production expands Discourages or blocks competition from market entry Boosts sales and provides large profit increases Requires gear up for mass production Selling large volumes at low prices Strategy to gain market share may fail Notes: Penetration pricing is at the opposite end of the spectrum from price skimming. By charging a low price for a product, a larger share of the market is captured, resulting in lower production costs. It does, however, mean lower profit per unit, and a higher volume of sales is required to reach the break-even point. Penetration pricing does tend to discourage competition and is effective in a price-sensitive market. 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Status Quo Pricing Chapter 20 Setting the Right Price Advantages Disadvantages Simplicity Safest route to long-term survival for small firms Strategy may ignore demand and/or cost Notes: Status quo pricing means meeting the competition’s prices by charging an identical price or very close to the competition’s price. It is a simple method of pricing, but the strategy may ignore demand and/or cost. However, if the firm is small, meeting the competition’s prices may be the safest route to long-term survival. 1 © 2015 by Cengage Learning Inc. All Rights Reserved.

Identify the legal and ethical constraints on pricing decisions
Chapter 20 Setting the Right Price The Legality of Price Strategy Identify the legal and ethical constraints on pricing decisions 2 © 2015 by Cengage Learning Inc. All Rights Reserved.

The Legality of Price Strategy
Chapter 20 Setting the Right Price The Legality of Price Strategy Unfair Trade Practices Price Fixing Price Discrimination Notes: The issues that limit pricing decisions are unfair trade practices, price fixing, price discrimination, and predatory pricing. Predatory Pricing 2 © 2015 by Cengage Learning Inc. All Rights Reserved.

Unfair Trade Practices and Price Fixing
Chapter 20 Setting the Right Price Unfair Trade Practices and Price Fixing Unfair Trade Practices Acts Laws that prohibit wholesalers and retailers from selling below cost. Price Fixing An agreement between two or more firms on the price they will charge for a product. Notes: In over half the states, unfair trade practice acts put a floor under wholesale and retail prices, and selling below cost is illegal. Wholesalers and retailers must take a certain minimum percentage markup on their combined merchandise cost and transportation cost. The most common markup figures are 6 percent at the retail level and 2 percent at the wholesale level. If a specific wholesaler or retailer can provide “conclusive proof” that operating costs are lower than the minimum required figure, lower prices may be allowed. The intent of unfair trade practice acts is to protect small firms from retail giants like Walmart and Target, which operate efficiently on razor-thin profit margins. State enforcement of unfair trade practice laws has generally been lax, because low prices benefit local consumers. Price fixing is illegal under the Sherman Act and the Federal Trade Commission Act. Discussion Question/Team Activity Research examples of cases tried under the Sherman and Federal Trade Commission Acts. 2 © 2015 by Cengage Learning Inc. All Rights Reserved.

Chapter 20 Setting the Right Price Price Discrimination The Robinson-Patman Act of 1936: There must be price discrimination. Transaction must occur in interstate commerce. Seller must discriminate by price among two or more purchasers. Products sold must be commodities or tangible goods. Products sold must be of like grade and quality. There must be significant competitive injury. Notes: This slide outlines the six elements necessary for a violation of the Robinson-Patman Act. 2 © 2015 by Cengage Learning Inc. All Rights Reserved.

The Robinson-Patman Act of 1936:
Chapter 20 Setting the Right Price Price Discrimination The Robinson-Patman Act of 1936: Seller Defenses Cost Market Conditions Competition Notes: The Robinson-Patman Act provides three defenses for the seller charged with price discrimination. In each case the burden is on the defendant to prove the defense. Cost: A firm can charge different prices to different customers if the prices represent manufacturing or quantity discount savings. Market conditions: Price variations are justified if designed to meet fluid product or market conditions. Examples include the deterioration of perishable goods, the obsolescence of seasonal products, a distress sale under court order, or a legitimate going-out-of-business sale. Competition: A reduction in price may be necessary to stay even with the competition. 2 © 2015 by Cengage Learning Inc. All Rights Reserved.

Chapter 20 Setting the Right Price Predatory Pricing The practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. Notes: Predatory pricing is illegal under the Sherman Act and the Federal Trade Commission. However, proving the use of this practice is difficult and expensive. The Justice Department must show that the predator explicitly tried to ruin a competitor and that the predatory price was below the predator’s average variable cost. 2 © 2015 by Cengage Learning Inc. All Rights Reserved.

Tactics for Fine-Tuning the Base Price
Chapter 20 Setting the Right Price Tactics for Fine-Tuning the Base Price Explain how discounts, geographic pricing, and other pricing tactics can be used to fine-tune the base price 3 © 2015 by Cengage Learning Inc. All Rights Reserved.

Tactics for Fine-Tuning the Base Price
Chapter 20 Setting the Right Price Tactics for Fine-Tuning the Base Price Other pricing tactics Discounts Geographic pricing Notes: The base price is the general price level at which the company expects to sell a good or service. The general price level is correlated with the pricing policy: above the market, at the market, or below the market. The final step is to fine-tune the base price. Fine-tuning techniques include discounts, geographic pricing, and other pricing tactics. 3 © 2015 by Cengage Learning Inc. All Rights Reserved.

Discounts, Allowances, Rebates, and Value-Based Pricing
Chapter 20 Setting the Right Price Discounts, Allowances, Rebates, and Value-Based Pricing Quantity Discounts Cash Discounts Functional Discounts Seasonal Discounts Promotional Allowances Rebates Zero Percent Financing Value-Based Pricing Notes: A base price can be lowered through the use of discounts and the related tactics of allowances, rebates, low or zero percent financing, and value-based pricing. Discounts are used to encourage customers to do what they would not ordinarily do, such as pay cash, take delivery out of season, or performing certain functions within a distribution channel. The most common tactics are: Quantity discounts with lower prices for buying in multiple units of above a specified dollar amount. Cash discounts offered for prompt payment of a bill. Functional discounts (trade discounts) are offered when channel intermediaries perform a service for the manufacturer. Seasonal discounts are lower prices for buying merchandise out of season. Promotional allowances (or trade allowance) are payments to dealers for promoting the manufacturer’s products. Rebates are cash refunds given for purchasing a product within a specified period. Zero percent financing offers no interest charge to increase sales. However, it does cost the manufacturers. Value-based pricing sets the price at a level that seems to the customer to be a good price compared to other prices. The basic assumption with value-based pricing is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers. 3 © 2015 by Cengage Learning Inc. All Rights Reserved.

Pricing Products Too Low
Chapter 20 Setting the Right Price Pricing Products Too Low Sometimes managers price their products too low, thereby reducing company profits. This seems to happen for two reasons: Managers attempt to buy market share through aggressive pricing. Managers have a natural tendency to want to make decisions that can be justified objectively. Notes: Pricing products too low reduces company profits. This happens for two reasons: The company is attempting to buy market share through aggressive pricing. Managers have a tendency to make decisions that can be justified objectively. As a result, pricing decisions are made based on current costs, projected short-term share gains, or current competitive prices rather than on long-term profitability. 3 © 2015 by Cengage Learning Inc. All Rights Reserved.

Geographic Pricing FOB Origin Pricing Uniform Delivered Zone Pricing
Chapter 20 Setting the Right Price Geographic Pricing FOB Origin Pricing Uniform Delivered Zone Pricing Freight Absorption Basing-Point The buyer absorbs the freight costs from the shipping point (“free on board”). The seller pays the freight charges and bills the purchaser an identical, flat freight charge. The U.S. is divided into zones, and a flat freight rate is charged to customers in a given zone. The seller pays for all or part of the freight charges and does not pass them on to the buyer. The seller charges freight from a basing point, regardless of the city from which the goods are shipped. Notes: The most common methods of geographic pricing are described on this slide. © 2015 by Cengage Learning Inc. All Rights Reserved.

Chapter 20 Setting the Right Price Other Pricing Tactics Single-Price Tactic All goods offered at the same price Flexible Pricing Different customers pay different prices Trade-Ins Exchanging one item for a credit towards another. Used often at car dealerships Professional Services Pricing Used by professionals with experience, training or certification Price Lining Several line items at specific price points Leader Pricing Sell product at near or below cost Bait Pricing Lure customers through false or misleading price advertising Odd-Even Pricing Odd-number prices imply bargain Even-number prices imply quality Price Bundling Combining two or more products in a single package Two-Part Pricing Two separate charges to consume a single good Pay What You Want Product price chosen by customers Notes: Other pricing tactics are unique and defy neat categorization. Managers use these tactics to stimulate demand for specific products, to increase store patronage, and to offer a wider variety of merchandise at a specific price point. These pricing tactics are described on this slide. Discussion/Team Activity: Discuss products and/or businesses that utilize these pricing tactics. © 2015 by Cengage Learning Inc. All Rights Reserved.

Businesses impose consumer penalties if...
Chapter 20 Setting the Right Price Consumer Penalties An irrevocable loss of revenue is suffered Additional transaction costs are incurred Businesses impose consumer penalties if... Notes: More businesses are adopting consumer penalties—extra fees paid by consumers for violating the terms of a purchase agreement. Discussion Question/Team Activity Have your students brainstorm a list of common consumer penalties in different industries. 3 © 2015 by Cengage Learning Inc. All Rights Reserved.

Product Line Pricing Setting prices for an entire line of products. 4
Chapter 20 Setting the Right Price Product Line Pricing Setting prices for an entire line of products. Online Beauty.com Does Beauty.com use a product line pricing strategy? Choose a brand and view the product list and pricing sheet. What evidence do you see of product line pricing? Of other pricing strategies? Notes: In product line pricing, the manager tries to achieve maximum profits for the entire line rather than for a single component of the line. 4 © 2015 by Cengage Learning Inc. All Rights Reserved.

Relationships among Products
Chapter 20 Setting the Right Price Relationships among Products Complementary Substitutes Neutral Notes: In setting product line prices, the manager first determines the relationship among the products in the line: Complementary: An increase in the sale of one good causes an increase in demand for the complementary product. Substitutes: Two products in a line can be substitutes for each other. If buyers buy one item in the line, they are less likely to buy a second item in the line. Neutral: A neutral relationship can exist between two products. Demand for one of the products is unrelated to demand for the other. 4 © 2015 by Cengage Learning Inc. All Rights Reserved.

Chapter 20 Setting the Right Price Joint Costs Costs that are shared in the manufacturing and marketing of several products in a product line. Notes: If costs are shared in the manufacturing and marketing of several products in the product line, product pricing is more difficult. Some common assignments of joint costs include a weight basis, market value, or quantity sold. Discussion/Team Activity: Name products that may require joint cost pricing. 4 © 2015 by Cengage Learning Inc. All Rights Reserved.

of pricing during periods of inflation
Chapter 20 Setting the Right Price Pricing during Difficult Economic Times Describe the role of pricing during periods of inflation and recession 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Inflation Chapter 20 Setting the Right Price Cost-Oriented Tactics High Inflation Demand-Oriented Notes: When the economy is characterized by high inflation, special pricing tactics are often necessary. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Problems with Cost-Oriented Tactics
Chapter 20 Setting the Right Price Problems with Cost-Oriented Tactics A high volume of sales on an item with a low profit margin may still make the item highly profitable. Eliminating a product may reduce economies of scale. Eliminating a product may affect the price-quality image of the entire line. Notes: One common cost-oriented tactic is culling products with a low profit margin. However this tactic may backfire for the three reasons listed on this slide. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Cost-Oriented Tactics
Chapter 20 Setting the Right Price Delayed-quotation pricing: Used for industrial installations and many accessory items; firm price is not set until the item is finished or delivered. Escalator pricing: Final selling price reflects cost increases incurred between the order time and the delivery time. Hold prices constant, but add new fees. Notes: Cost-oriented tactics include delayed-quotation pricing, which is used for industrial installations and accessory items. Price is not set until the item is either finished or delivered. Examples include builders of nuclear power plants, ships, airports, and office towers. Escalator pricing is similar to delayed-quotation pricing in that the final selling price reflects costs increases incurred between the time an order is placed and the time delivery is made. Another tactic is to hold prices constant but add new fees. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Maintaining a Fixed Gross Margin
Cost-Oriented Tactics Chapter 20 Setting the Right Price Increased Production Costs Decreased Demand Price Increase Maintaining a Fixed Gross Margin Notes: Any cost-oriented pricing policy that tries to maintain a fixed gross margin under all conditions can lead to a vicious circle, as shown in the diagram on this slide. A price increase will result in decreased demand, which in turn increases production costs because of lost economies of scale. Increased production costs require a further price increase, and so on. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Demand-Oriented Tactics
Chapter 20 Setting the Right Price Price Shading The use of discounts by salespeople to increase demand for one or more products in a line. Notes: Demand-oriented tactics use price to reflect changing patterns of demand caused by inflation or high interest rates. Often price shading becomes habitual and is done routinely without much forethought. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Create unique offerings
Demand-Oriented Tactics Chapter 20 Setting the Right Price Strategies to Make Demand More Inelastic Cultivate selected demand Create unique offerings Change the package design Heighten buyer dependence Notes: To make the demand for a good or service more inelastic and to create buyer dependency, a company can use the strategies as shown on this slide: Cultivate selected demand: Target prosperous customers who will pay extra for convenience or service. Create unique offerings: By studying buyers’ needs, the seller can design distinctive products to fit a buyers’ needs and establish a beneficial relationship. Change the package design: Companies pass on higher costs by shrinking the product sizes but keep prices the same. Heighten buyer dependence: Provide additional value-added services and training with product offerings to freeze out competition and support higher prices. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Bundling or Unbundling
Recession Chapter 20 Setting the Right Price Value-Based Pricing Bundling or Unbundling Notes: Effective pricing tactics during recession are value-based pricing and bundling. Value-based pricing stresses to customers that they are getting a good value for their money. Researchers have found that relaxed shoppers are willing to pay up to 15 percent more than less-relaxed ones. Bundling or unbundling of features or services gives a perception of higher value. Bundling can be demonstrated in vacation packages that include lodging, meals, and massages. Prices often fall during a recession as competitors try desperately to maintain demand for their wares. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Renegotiating contracts Keeping the pressure on
Supplier Strategies during Recession Chapter 20 Setting the Right Price Renegotiating contracts Offering help Keeping the pressure on Paring down suppliers Notes: In a recession, prices often fall so that companies can maintain demand for their products. Falling prices are an incentive to lower costs since falling prices mean lower profits or no profits. Suppliers can be excellent sources of cost savings. Some ways companies can use cost-saving strategies with suppliers are listed on this slide. Renegotiating contracts: Demanding lower prices or rebidding the contracts. Offering help: Help suppliers’ plants reorganize and increase productivity. Keeping the pressure on: Set annual, across-the-board cost-reduction targets. Paring down suppliers: Reduce the number of suppliers and boost purchases from those that remain. 5 © 2015 by Cengage Learning Inc. All Rights Reserved.

Chapter 20 Setting the Right Price Chapter 20 Video BoltBus BoltBus is Greyhound’s express bus service that operates off curb-sides in major metropolitan areas. This video clip covers BoltBus pricing decisions and how the company decides what the prices are as well as how it keeps costs down. CLICK TO PLAY VIDEO © 2015 by Cengage Learning Inc. All Rights Reserved.

Scripps Networks Interactive
Chapter 20 Setting the Right Price Part 6 Video Scripps Networks Interactive Pricing Decisions Scripps Networks Interactive is a group of television networks including such popular channels as Food Network, HGTV, and The Cooking Channel. In this clip, executives from Scripps discuss how they decide what pricing decisions to make based on their major audience, and how those decisions can also affect distribution and the content itself. CLICK TO PLAY VIDEO © 2015 by Cengage Learning Inc. All Rights Reserved.

Setting the Right Price

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