Pricing the Product

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Chapter Objectives

• Explain the importance of pricing and how prices can take both monetary and nonmonetary forms

• Understand the pricing objectives marketers typically have in planning pricing strategies

• Describe how marketers use costs, demands, and revenue to make pricing decisions

• Understand some of the environmental factors that affect pricing strategies

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Chapter Objectives (cont’d)

• Understand key pricing strategies

• Explain pricing tactics for single and multiple products, and for pricing on the Internet

• Understand the opportunities for Internet pricing strategies

• Describe the psychological, legal, and ethical aspects of pricing

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Real People, Real Choices

• Taco Bell (Danielle Blugrind)• In order to differentiate itself

from the competition, Taco Bell needed to update its value pricing menu.Option 1: price entire menu

at $1.29

Option 2: price items at 99

cents and $1.29

Option 3: price items at

99 cents, $1.19, and $1.29TACO BELL

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“Yes, but what does it cost?”

• Price: the assignment of value, or the amount the consumer must exchange to receive the offeringMoney, goods, services, favors,

votes, or anything else that has value to the other party

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Figure 11.1:Steps in Price Planning

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Step 1: Develop Pricing Objectives

• Sales or market share objectives• Profit objectives • Competitive effect objectives • Customer satisfaction objectives• Image enhancement objectives

ROLLS-ROYCE

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Step 2: Estimate Demand

• Demand: customers’ desires for a productHow much of a product are

customers willing to buy as its price goes up or down?

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Demand Curves

• Law of demand: as price goes up, quantity demanded goes down.

• For prestige products, a price increase may actually result in an increase in quantity demanded.

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Figure 11.2: Demand Curves for Normal and Prestige Products

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Shifts in Demand Curve

Changes in marketing strategy (improved product, new advertising) or non-marketing activities can cause upward or downward shifts in demand.

At a given price, demand is greater or less than before the shift.

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Figure 11.3: Shift in Demand Curve

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Estimating Demand

• Marketers predict total demand by estimating potential buyers for a product, then multiplying number of buyers times average amount of each buyer’s purchase.

• Then they predict what the company’s share of the total market will be.

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Price Elasticity of Demand

• The percentage change in unit sales that results from a percentage change in price.

Figure 11.5: Price Elastic and Inelastic Demand Curves

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Elastic Demand

• A change in price results in a substantial change in quantity demanded. If price is increased, revenues decrease, and vice-versa.Non-necessities (pizza) generate elastic demand.Availability of close substitute products facilitates elastic demand.

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Inelastic Demand

• A change in price has little or no effect on quantity demanded. If price is increased, revenues increase. The demand for necessities (food and electricity) is

generally inelastic.

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Cross-elasticity of Demand

• Changes in prices of other products affect a product’s demand.Products are substitutes: increase in price of one will

increase demand for other (bananas vs. strawberries).

One product is essential for use of second: increase in price of one decreases demand for other (increasing price of gas lowers demand for tires).

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Group Activity

• Your group are marketers for a candy bar manufacturer. You feel it’s time to increase price, but you’re concerned the increase might not be profitable.--How would you investigate elasticity of demand?

--What findings would lead you to increase price?

--What findings would lead you not to increase it?

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Step 3: Determine Costs

• Variable costs: costs of production that are tied to and vary depending on the number of units produced. Average variable costs may change as the number of

products produced changes.

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Figure 11.6: Variable Costs at Different Levels of Production

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Step 3: Determine Costs (cont’d)

• Fixed costs: costs of production that don’t change with number of units producedRent, cost of owning/maintaining factory, utilities,

equipment, fixed salaries of firm’s executives

Average fixed cost: fixed cost per unit (total fixed costs divided by number of units produced) will decrease as number of units produced increases.

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Step 3: Determine Costs (cont’d)

• Total costs: total of fixed costs and variable costs for a set number of units produced.

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Break-Even Analysis

• A method for determining the number of units a firm must produce and sell at a given price to cover all its costs.

• Break-even point: point at which a firm doesn’t lose any money and doesn’t make any profit.

Song AirlinesVideo

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Figure 11.7: Break-Even Analysis

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Break-Even Analysis (cont’d)

• Break-even point (in units) = (total fixed costs) divided by (contribution per unit)Contribution per unit: the difference between the price

the firm charges for a product and the variable costs

• Break-even point (in dollars) = (total fixed costs) divided by [1 - (variable cost per unit divided by price)]

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Marginal Analysis

• A method that uses cost and demand to identify the price that will maximize profits. Marginal cost: increase in total costs from producing

one additional unit of a productMarginal revenue: increase in total income or revenue

from selling one additional unit of a product (decreases with each additional unit sold)

Profit is maximized where marginal cost is exactly equal to marginal revenue.

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Figure 11.8: Marginal Analysis

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Marketing Math Activity

• You and your friend have decided to go into business together manufacturing handbags. --You know fixed costs will be $120,000 a year, and

you expect variable costs to be $28 per bag. --If you plan to sell the bags to retail stores for $35,

how many must you sell to break even?

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Step 4: Evaluate the Pricing Environment

• The economyBroad economic trends Recessions, Inflation

• The competition• Consumer trends

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Step 5: Choose a Price Strategy

• Pricing strategies based on costSimple to calculate and

relatively risk free

Cost-plus pricing: total all product costs and add markup

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Step 5: Choose a Price Strategy (cont’d)

• Pricing strategies based on demandBased on estimate of quantity a firm can sell at

different pricesTarget costing: identify quality and functionality

customers need and price they’re willing to pay before designing product.

Yield management pricing: charge different prices to different customers to manage capacity

PRICELINE.COM

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Step 5: Choose a Price Strategy (cont’d)

• Pricing strategies based on the competitionPricing near, at, above, or below the competitionPrice leadership strategy: industry giant announces

price, and competitors get in line or drop out

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Discussion

• In what ways is a price leadership strategy good or bad for consumers?

• Should governments allow price leadership?

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Step 5: Choose a Price Strategy (cont’d)

• Pricing strategies based on customers’ needsValue pricing or everyday low pricing (EDLP): pricing

strategy in which a firm sets prices that provide ultimate value to customers.

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Step 5: Choose a Price Strategy (cont’d)

• New-product pricingSkimming price: a very high premium

price

Penetration pricing: a very low price to encourage more customers to purchase

Trial pricing: low price for a limited period of time

HP FINANCIAL CALCULATORS

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Discussion

• In pricing new products, marketers may choose a skimming or a penetration pricing strategy. --What is the advantage or disadvantage of this

practice for consumers? --For the industry as a whole?

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Step 6: Develop Pricing Tactics

• Pricing for individual productsTwo-part pricing: offering two

separate types of payments to purchase the product

Payment pricing: breaking total price into smaller amounts payable over time

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Step 6: Develop Pricing Tactics (cont’d)

• Pricing for multiple productsPrice bundling: selling two or more goods or services as a

single package for one price

Captive pricing: pricing two products that work only when used together

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Step 6: Develop Pricing Tactics (cont’d)

• Distribution-based pricingF.O.B. (free on board) origin pricing

F.O.B delivered pricing

Basing-point pricing

Uniform delivered pricing

Freight absorption pricing

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Step 6: Develop Pricing Tactics (cont’d)

• Discounting for channel membersList price (suggested retail price): price that

manufacturer sets as appropriate for end consumer to pay

Trade or functional discounts: set percentage discounts off list price for each channel level

Quantity discounts: reduced prices for purchases of larger quantities

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Step 6: Develop Pricing Tactics (cont’d)

• Discounting for channel members (continued)Cash discounts: enticements to customers to pay bills

quickly (2% 10 days, net 30 days)

Seasonal discounts: price reductions offered during certain times of year

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Pricing and Electronic Commerce

• Dynamic pricing strategies: seller easily adjusts price to meet changes in marketplace.Cost of changing prices on Internet

is practically zero.

Firms can respond quickly and frequently to changes in costs, supply, and/or demand.

CHEAPTICKETS.COM

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Pricing and Electronic Commerce (cont’d)

• Online auctions (eBay.com)E-commerce allows shoppers to purchase products

through online bidding.

• Pricing advantages for online shoppersConsumers gain control. Search engines and “shopbots” make customers

more price-sensitive.Consumers have more negotiating power.

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Psychological Issues in Pricing

• Buyer’s pricing expectation Internal reference price: consumers use a price/price

range to evaluate product’s cost.• Assimilation effect • Contrast effect

Price/quality inferences: consumers assume higher-priced product has higher quality.

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Discussion

• Consumers often make price-quality inferences about products.--What are some products for

which you make price-quality inferences?

--Do your inferences make sense?

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Psychological Pricing Strategies

• Odd-even pricing: prices ending in 99 rather than 00 lead to increased sales.

• Price lining: items in a product line sell at different price points.

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Legal and Ethical Considerations in Pricing

• Deceptive pricing practicesGoing-out-of-business sale Bait-and-switch

• Unfair sales actsLoss-leader pricing Unfair sales acts

• Illegal business-to-business price discrimination

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Discussion

• In loss-leader pricing, retailers advertise and sell an item below cost to get customers into the store. --Do you consider this an unethical practice? --Who benefits and who is hurt by it? --Should the practice be made illegal (some states

have done so)? --How is loss-leader pricing different from bait-and-

switch pricing?

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Legal and Ethical Considerations in Pricing (cont’d)

• Price fixing: two or more companies conspire to keep prices at a certain levelHorizontal price fixing Vertical price fixing

• Predatory pricing: company sets a very low price for purpose of driving competitors out of business

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Real People, Real Choices

• Taco Bell (Danielle Blugrind)• Danielle chose option 3:

price items at 99 cents, $1.19, and $1.29By carefully tuning its pricing strategy,

Taco Bell is reclaiming its position as purveyor of fast-food value for the money.

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Marketing Plan Exercise

• A new seaside resort offers luxury rentals for a few days, a week, or longer. Consider possible pricing strategies -- cost-plus, yield management, everyday low pricing, skimming, and penetration and trial pricing. --What pricing strategy do you recommend for the resort ? --What pricing tactics do

you suggest?

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Marketing in Action Case:You Make the Call

• What is the decision facing True Religion?

• What factors are important in understanding this decision situation?

• What are the alternatives?

• What decision(s) do you recommend?

• What are some ways to implement your recommendation?

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Keeping It Real: Fast-Forward to Next Class, Decision Time at General Motors R*Works

• Meet Vince O’Brien, VP-Regional Managing Director for General Motors R*Works

• R*Works: regional promotional agency for GM; manages partnerships with sports organizations

• The decision: How to get dealers to support R*Works ski mountain promotional partnerships?