Chapter 12 Pricing Concepts and Management TEACHING RESOURCES QUICK REFERENCE GUIDE Resource Location Purpose and Perspective IRM, p. 293 Lecture Outline IRM, p. 294 Discussion Starters IRM, p. 304 Class Exercises IRM, p. 305 Chapter Quiz IRM, p. 308 Semester Project IRM, p. 309 Answers to Issues for Discussion and Review IRM, p. 310 Answers to Marketing Applications IRM, p. 314 Answers to Internet Exercise IRM, p. 316 Answers to Developing Your Marketing Plan IRM, p. 317 Comments on Video Case 12 IRM, p. 318 PowerPoint Slides Instructor’s website Note: Additional resources may be found on the accompanying student and instructor websites at www.cengagebrain.com. Purpose and Perspective This chapter introduces basic pricing concepts and issues. First, it discusses price and nonprice competition. Next, it discusses the stages for establishing prices. The chapter identifies the pricing objectives like survival, profit, market share, etc. Next, the chapter talks about how marketers assess the target market’s evaluation of price. It follows this with an explanation of demand curves, demand fluctuations, and assessment of price elasticity of demand. Next, it explores marginal analysis and break-even analysis. It also identifies and examines various factors that affect marketers’ pricing decisions. It also discusses how competitors’ prices are evaluated. The chapter also discusses selecting a basis for pricing: cost, demand, and/or competition. It discusses the various types of pricing strategies. It examines the determination of a specific price. Finally, it examines several issues associated with the pricing of products for business markets, focusing on price discounting, geographic pricing, and transfer pricing. LECTURE OUTLINE Price competition occurs when a seller emphasizes a product’s low price and sets a price that equals or beats that of competitors. Non-price competition is competition based on factors other than price. It is used most effectively when a seller can distinguish its product through distinctive product quality, customer service, promotion, packaging, or other features. Marketers can use the eight stages of a process when setting prices. Figure 12.1 illustrates these stages. • Stage 1 is developing a pricing objective that is compatible with the organization’s overall marketing objectives. • Stage 2 entails assessing the target market’s evaluation of price. • In Stage 3, marketers should examine a product’s demand and the price elasticity of demand. • Stage 4 consists of analyzing demand, cost, and profit relationships—it is a necessary step in estimating the economic feasibility of various price alternatives. • Stage 5 involves evaluating competitors’ prices, which helps determine the role of price in the marketing strategy. • Stage 6 requires choosing a basis for setting prices. • Stage 7 is selecting a pricing strategy, or determining the role of price in the marketing mix. • Stage 8 involves determining the final price. This final step depends on environmental forces and marketers’ understanding and use of a systematic approach to establishing prices. I. Development of Pricing Objectives A. The first step in setting prices is developing pricing objectives—goals that describe what a firm wants to achieve through pricing. 1. Developing pricing objectives is an important task because they form the basis for decisions for other stages of the pricing process. 2. Pricing objectives must be consistent with organizational and marketing objectives pricing objectives influence decisions in many functional areas, including finance, accounting, and production. 3. A marketer can use both short- and long-term pricing objectives and can employ one or more multiple pricing objectives. B. Survival 1. One of the most fundamental pricing objectives is survival. This generally means temporarily setting prices low, even at times below costs, in order to attract more sales. a. Because price is a flexible variable, it is sometimes used to keep a company afloat by increasing sales volume. b. Most organizations will tolerate short-run losses, internal upheaval, and other difficulties if these conditions are necessary for survival. C. Profit 1. The objective of profit maximization is rarely operational because it is difficult to measure its achievement. a. Therefore, profit objectives tend to be set at levels that the owners and top-level decision makers view as satisfactory and attainable. 2. Specific profit objectives may be stated in terms of either actual dollar amounts or in terms of a percentage of sales revenues. D. Return on Investment 1. Pricing to attain a specified rate of return on the company’s investment is a profit-related pricing objective. 2. Most pricing objectives based on return on investment (ROI) are achieved by trial and error because not all cost and revenue data needed to project the return on investment are available when setting prices. E. Market Share 1. Many firms establish pricing objectives to maintain or increase market share, which is a product’s sales in relation to total industry sales, in part because they recognize that high relative market share often translates into higher profits. 2. Maintaining or increasing market share need not depend on growth in industry sales. a. An organization’s market share can increase even when sales for the total industry are flat or decreasing. b. An organization’s sales volume can increase while its market share decreases if the overall market is growing. F. Cash Flow 1. Some organizations set prices to recover cash as quickly as possible. 2. Financial managers are interested in quickly recovering capital that has been spent to develop products. 3. A possible disadvantage of this pricing objective is high prices, which might enable competitors with lower prices to gain a large share of the market. G. Status Quo 1. In some cases, an organization may be in a favorable position and may set an objective of status quo. 2. Status quo objectives can focus on several dimensions, including maintaining a certain market share, meeting (but not beating) competitors’ prices, achieving price stability, or maintaining a favorable public image. 3. A status quo pricing objective can reduce a firm’s risks by helping stabilize demand for its products. 4. The use of status quo pricing objectives sometimes minimizes price as a competitive tool, which can lead to a climate of non-price competition within an industry. H. Product Quality 1. A high price on a product may have the effect of signaling to customers that the product is of a high quality. 2. An objective of product quality leadership in the market normally results in charging a high price to cover the high product quality and, perhaps, the high cost of materials, research, and development. 3. The products and brands that customers perceive to be of high quality are more likely to survive in a competitive marketplace because they trust these products more, even if the prices are higher. II. Assessment of the Target Market’s Evaluation of Price A. After developing pricing objectives, marketers next must assess the target market’s evaluation of price. 1. The importance of price depends on the type of product, the type of target market, and the purchase situation. B. Today, because some consumers are seeking less-expensive products and shopping more selectively, some manufacturers and retailers are focusing on the value of their products in communications with customers. 1. Value combines a product’s price with quality attributes, which are used by customers to differentiate between competing brands. 2. Understanding the importance of a product to customers, as well as their expectations of quality and value, helps a marketer correctly assess the target market’s evaluation of price. III. Analysis of Demand A. Marketing research and forecasting techniques yield data such as estimates of sales potential, or the quantity of a product that could be sold during a specific period. 1. These estimates help marketers to establish the relationship between a product’s price and the quantity demanded. B. The Demand Curve 1. For most products, there is an inverse relationship between price and demand. The quantity demanded goes up as the price goes down and goes down as the price goes up. 2. A normal demand curve is a graph of the quantity of products expected to be sold at various prices, if other factors remain constant. a. Demand depends on other factors in the marketing mix, including product quality, promotion, and distribution. 3. There are many types of demand, and not all conform to the classic demand curve. Prestige products, for example, tend to sell better at high prices than at low ones. C. Demand Fluctuations 1. Changes in buyers’ needs, variations in the effectiveness of other marketing mix variables, the presence of substitutes, and dynamic environmental factors can influence demand. 2. In some cases, demand fluctuations are predictable, but they are unpredictable in others, creating problems for some companies unless they can learn to anticipate fluctuations and develop new products and prices to respond accordingly. D. Assessing Price Elasticity of Demand 1. Price elasticity of demand provides a measure of the sensitivity of consumer demand for a product or a product category to changes in price; it is formally defined as the percentage change in quantity demanded relative to a given percentage change in price. 2. Setting a price is much easier if marketers can determine the price elasticity of demand. a. If demand is elastic, shift in price causes an opposite change in total revenue: an increase in price will decrease total revenue, and a decrease in price will increase total revenue. b. Inelastic demand results in the same direction as total revenue: an increase in price will increase total revenue, and a decrease in price will decrease total revenue. 3. Marketers cannot base prices solely on elasticity considerations; they must also consider the costs associated with different sales volumes and evaluate what happens to profits. IV. Demand, Cost, and Profit Relationships A. The analysis of demand, cost, and profit is important because customers are becoming less tolerant of price increases, which forces manufacturers to find new ways to maintain high quality and low costs. B. Marginal Analysis 1. Marginal analysis examines what happens to a firm’s costs and revenues when production (or sales volume) is changed by one unit. 2. To determine the costs of production, it is necessary to distinguish among several types of costs. a. Fixed costs do not vary with changes in the number of units produced or sold. (1) Average fixed cost is the fixed cost per unit produced, and is calculated by dividing fixed costs by the number of units produced. b. Variable costs directly relates to changes in the number of units produced or sold. They are usually constant per unit. (1) Average variable cost is the variable cost per unit produced, calculated by dividing the variable costs by the number of units produced. c. Total cost is the sum of the average fixed costs and the average variable costs, multiplied by the quantity produced. (1) The average total cost is the sum of the average fixed cost and the average variable cost. d. Marginal cost (MC) is the extra cost a firm incurs when it produces one additional unit of a product. e. Average fixed cost declines as output increases. Average total cost decreases as long as MC is less than the average total cost, and it increases when MC rises above average total cost. 3. Marginal revenue (MR) is the change in total revenue that occurs when a firm sells an additional unit of a product. a. Most firms face downward-sloping demand curves for their products; in other words, they must lower their prices to sell additional units. (1) This situation means that each additional unit of product sold provides the organization with less revenue than the previous unit sold. (2) Eventually MR reaches zero, and the sale of additional units actually reduces the organization’s profits. b. The point of maximum profit is the point at which marginal costs are equal to marginal revenues. 4. This discussion of marginal analysis may give the false impression that pricing can be highly precise. a. If revenue (demand) and cost (supply) remained constant, prices could be set for maximum profits. In practice, however, cost and revenue frequently change. 5. Marginal analysis is to be used only as a model; the marketer can benefit by understanding the relationship between MC and MR in setting prices of existing products. C. Break-even Analysis 1. The break-even point is the point at which the costs of producing the product equal the revenue from selling the product. It is calculated by dividing the fixed costs by price minus variable costs. 2. To use break-even analysis effectively, a marketer should determine the break-even point for several alternative prices in order to compare the relative effects on total revenue, total costs, and the break-even point. This comparative analysis will identify the highly undesirable price alternatives that should be avoided. 3. Breakeven analysis is simple and straightforward, but it assumes that the quantity demanded is basically fixed (inelastic) and that the major task in setting prices is to recover costs. It does not focus on how to achieve a pricing objective. V. Evaluation of Competitors’ Prices A. Marketers are generally in a better position to establish prices when they know the competition’s prices; discovering competitors’ prices may be a regular function of marketing research. B. Competitors’ prices are often closely guarded secrets and may be difficult to uncover. C. Marketers in an industry in which price competition prevails need competitive price information to ensure their organization’s prices are the same, or slightly lower than, their competitors’ prices. D. An organization may set its prices slightly above competitors’ prices to give its products an exclusive image, or it may use price as a competitive tool and price its products below those of competitors. VI. Selection of a Basis for Pricing A. The sixth stage in the price setting process involves selecting a basis for pricing: cost, demand, and/or competition. B. The appropriate pricing basis is affected by the type of product, the market structure of the industry, the brand’s market share position relative to competing brands, and customer characteristics. C. Cost-Based Pricing 1. When using cost-based pricing, an organization determines price by adding a flat dollar amount or a percentage to the cost of the product. It does not always take into account the economic aspects of supply and demand. 2. Cost-based pricing is straightforward and easy to implement. Two common forms of cost-based pricing are cost-plus and markup pricing. a. Cost-plus pricing is a method whereby the seller’s costs are determined (usually during a project or after a project is completed), and then a specified dollar amount or percentage of the cost is added to the seller’s cost to establish the price. (1) This is appropriate when production costs are difficult to predict. (2) One pitfall for the buyer is that the seller may increase stated costs to establish a larger profit base. (3) For industries in which cost-plus pricing is common and sellers have similar costs, price competition may not be especially intense. b. Through markup pricing, which is common among retailers, a product’s price is derived by adding a predetermined percentage of the cost, called markup, to the cost of the product. (1) Markups can range a great deal, depending on the product and the situation. (2) Using a rigid percentage markup for a specific product category reduces pricing to a routine task that can be performed quickly. D. Demand-Based Pricing 1. With demand-based pricing, customers pay a higher price at times when demand for the product is strong and a lower price when demand is weak. 2. To use demand-based pricing, a marketer must be able to estimate the amounts of a product consumers will demand at different times and how demand will be affected by changes in the price; effectiveness depends on the marketer’s ability to estimate demand accurately. 3. Compared with cost-based pricing, demand-based pricing places a firm in a better position to reach high profit levels, assuming demand is strong at times and buyers value the product at levels sufficiently above the product’s cost. E. Competition-Based Pricing 1. Competition-based pricing is pricing primarily influenced by competitors’ prices. a. This is a common method when competing products are relatively homogeneous and the organization is serving markets in which price is a key purchase consideration. 2. A firm that uses competition-based pricing may choose to price below competitors’ prices or at the same level. VII. Selection of a Pricing Strategy A. A pricing strategy is an approach or a course of action designed to achieve pricing and marketing objectives. Pricing strategies help marketers solve the practical problems of setting prices. B. New-Product Pricing 1. The two primary types of new-product pricing strategies are price skimming and penetration pricing. An organization can use one or both over a period of time. a. Price Skimming (1) Some consumers are willing to pay a high price for an innovative product, either because of its novelty or because of the prestige or status that ownership confers. (2) Price skimming is the strategy of charging the highest possible price for a product during the introduction stage of its life-cycle. b. Penetration Pricing (1) At the opposite extreme, penetration pricing is the strategy of setting a low price for a new product. (2) The main purpose of setting a low price is to build market share quickly in order to encourage product trial by the target market and discourage competitors from entering the market. C. Differential Pricing 1. An important issue in pricing is whether to use a single price or different prices for the same product. a. Using a single price has several benefits, including that it is simple, easily understood by employees and customers, and it reduces the chance of an adversarial relationship developing between marketer and customer. 2. Differential pricing means charging different prices to different buyers for the same quality and quantity of product. a. The market must consist of multiple segments with different price sensitivities, and the pricing method should be used in a way that avoids confusing or antagonizing customers. b. Negotiated Pricing (1) Negotiated pricing occurs when the final price is established through bargaining between the seller and the customer. (2) Even when there is a predetermined stated price or a price list, negotiated pricing may still be used to establish the final sales price. c. Secondary-Market Pricing (1) Secondary-market pricing means setting one price for the primary target market and a different price for another market. (2) Often the price charged in the secondary market is lower. (3) However, when the costs of serving a secondary market are higher than normal, secondary-market customers may have to pay a higher price. d. Periodic Discounting (1) Periodic discounting is the temporary reduction of prices on a patterned or systematic basis. (a) For example, many retailers have annual holiday sales, and some apparel stores have regular seasonal sales. (2) A major problem with periodic discounting is, if the discounts follow a pattern, customers may wait to make purchases until they can get the sale price. e. Random Discounting (1) Random discounting is temporarily reducing prices on an unsystematic basis. (a) This is done to attract new customers and reduce predictability of price reductions by current customers. f. Psychological Pricing (1) Psychological pricing strategies encourage purchases based on consumers’ emotional responses, rather than on economically-rational ones. (a) These strategies are used primarily for consumer products, rather than business products, because most business purchases follow a systematic and rational approach. g. Odd-Number Pricing (1) Odd-number pricing is the strategy of setting prices using odd numbers that are slightly below whole-dollar amounts. (2) Sellers who use this strategy believe that odd-number prices increase sales because consumers register the dollar amount, not the cents. The strategy is not limited to low-priced items. h. Multiple-Unit Pricing (1) Many retailers (and especially supermarkets) practice multiple-unit pricing, setting a single price for two or more units of a product. (2) Especially for frequently-purchased products, this strategy can increase sales through encouraging consumers to purchase multiple units when they might otherwise have only purchased one at a time. i. Reference Pricing (1) Reference pricing means pricing a product at a moderate level and positioning it next to a more expensive model or brand in the hope that the customer will use the higher price as a reference point (i.e., a comparison price). j. Bundle Pricing (1) Bundle pricing is the packaging together of two or more products, usually of a complementary nature, to be sold for a single price. (2) To be attractive to customers, the single price usually is considerably less than the sum of the prices of the individual products. k. Everyday Low Prices (EDLPs) (1) To reduce or eliminate the use of frequent short-term price reductions, some organizations use an approach referred to as everyday low prices (EDLPs). (a) A major problem with this approach is that customers can have mixed responses to it. l. Customary Pricing (1) In customary pricing, certain goods are priced on the basis of tradition. m. Product-Line Pricing (1) Product-line pricing means establishing and adjusting the prices of multiple products within a product line. (2) Product-line pricing can provide marketers with flexibility in setting prices. (3) When marketers employ product-line pricing, they have several strategies from which to choose. (a) These include captive pricing, premium pricing, and price lining. n. Captive Pricing (1) When marketers use captive pricing, the basic product in a product line is priced low, but the price on the items required to operate or enhance it are higher. o. Premium Pricing (1) Premium pricing occurs when the highest-quality product or the most-versatile and most desirable version of a product in a product line is assigned the highest price. (2) Other products in the line are priced to appeal to price-sensitive shoppers or to those who seek product-specific features. p. Price Lining (1) Price lining is the strategy of selling goods only at certain predetermined prices that reflect explicit price breaks. (a) It eliminates minor price differences from the buying decision—both for customers and for managers who buy merchandise to sell in these stores. q. Promotional Pricing (1) Price, as an ingredient in the marketing mix, often is coordinated with promotion. (a) The two variables sometimes are so interrelated that the pricing policy is promotion-oriented. r. Price Leaders (1) Sometimes a firm prices a few products below the usual markup, near cost, or even below cost, which results in what is known as price leaders. (2) This type of pricing is used most often in supermarkets and restaurants to attract customers by offering especially low prices on a few items, with the expectation that they will purchase other items as well. s. Special-event pricing (1) Special-event pricing involves advertised sales or price cutting linked to a holiday, season, or event. (2) If the pricing objective is survival, then special sales events may be designed to generate necessary operating capital. t. Comparison Discounting (1) Comparison discounting sets the price of a product at a specific level and simultaneously compares it with a higher price. (a) The higher price may be the product’s previous price, the price of a competing brand, the product’s price at another retail outlet, or a manufacturer’s suggested retail price. VIII. Determination of a Specific Price A. A pricing strategy will yield a certain price or range of prices, which is the final stage in the price setting process. 1. However, this price may need refinement to make it consistent with circumstances, such as a sluggish economy, and with pricing practices in a particular market or industry. B. Pricing strategies should help in setting a final price. C. Marketers must establish pricing objectives, have considerable knowledge about target market customers; and determine demand, price elasticity, costs, and competitive factors. IX. Pricing for Business Markets A. Setting prices for business products can be quite different from setting prices for consumer products, owing to several factors such as size of purchases, transportation considerations, and geographic issues. B. The three types of pricing associated with business products are geographic pricing, transfer pricing, and discounting. C. Geographic Pricing 1. Geographic pricing strategies deal with delivery costs. 2. F.O.B. origin pricing stands for “free on board at the point of origin,” which means that the price does not include freight charges. a. It requires the buyer to pay the delivery costs, which include transportation from the seller’s warehouse to the buyer’s place of business. 3. F.O.B. destination indicates that the product price does include freight charges, and therefore the seller is responsible for these charges. D. Transfer Pricing 1. When one unit in an organization sells a product to another unit, transfer pricing occurs. 2. A transfer price is determined by calculating the cost of the product, which can vary depending on the types of costs included in the calculations. 3. The choice of the costs to include when calculating the transfer price depends on the company’s management strategy and the nature of the units’ interaction. E. Discounting 1. A discount is a deduction off the price of an item. 2. Producers and sellers offer a wide variety of discounts to their customers, including trade, quantity, cash, and seasonal discounts as well as allowances. a. Trade discounts are taken off the list prices and are offered to marketing intermediaries, or middlemen. b. Quantity discounts are given to customers who buy in large quantities. c. Cash discounts are incentives offered for prompt payment. d. A seasonal discount is a price reduction to buyers who purchase out of season. e. An allowance is a reduction in price to achieve a desired goal. DISCUSSION STARTERS Discussion Starter 1: Irrational Demand ASK: For an established product category, how are consumers’ minds changed about what the price should be for the product? Often newcomers to a category seek to shift our pricing expectations upward. This was what Starbucks had to achieve in order to be successful in the coffee market. Consumers were not used to paying $4 or more for a beverage. To convince consumers $4 for a beverage was an acceptable price, Starbucks had to change expectations and the demand for coffee. Today, Starbucks customers think of coffee beverages as gourmet treats rather than low-cost caffeine fixes. In the video found below, students will see how Starbucks accomplished this change in demand for coffee and how it impacted not only competitors for out-of-home coffee but also prices for in-home coffee. http://www.youtube.com/watch?v=FaO3aGmuNFc&feature=related Discussion Starter 2: Using Reference Pricing ASK: How do you know you are getting a good price? When shopping for an infrequently purchased product, consumers often rely on reference pricing. Many online and traditional stores now have both a reference price and in-store price for their products. This allows consumers to see the value of the product at a particular website or retailer. This use of reference prices is particularly common at discount websites or discount retailers. One online retailer that makes extensive use of reference pricing is Overstock.com. You can click on any category to see how reference prices are used on the site. (http://www.overstock.com) ASK: How effective is Overstock’s use of reference pricing to consumers? Often students will find reference prices a compelling argument for the value of an individual purchase. CLASS EXERCISES Class Exercise 1: Price versus Nonprice Competition This exercise examines price and nonprice competition, pricing objectives, and factors affecting price decisions. Prompt for students: Consider the following scenario and answer the questions. Prices of personal computers continue to drop because of the following conditions: a. Increased competition among PC makers, which operate on narrow margins. b. Increased consumer knowledge and sophistication, which encourages more consumers to use mail-order discount PC marketers. c. Decreased differences in quality and performance among competitors. Although Dell prices are still above some of the competitors, all PC manufacturers have been cutting prices to maintain market share. Questions: 1. Do you think Dell should compete through price or nonprice competition? What are the advantages and disadvantages of each approach? 2. If Dell were to continue competing on price, how might this affect other marketing mix variables? 3. If Dell drops its prices in the near future, what can you expect other PC makers to do? What kind of competitive situation is the PC industry (oligopoly, monopolistic, pure competition)? What does this imply for price setting? Answers: 1. In the past, Dell has not competed on a price basis, focusing instead on distinctive product features, service, product quality, and heavy promotion. This strategy generally leads to increased customer loyalty. Unfortunately for Dell, its products have been successfully imitated by competing manufacturers. This has forced Dell to compete on price alone, since PCs have become standardized products. Dell is not as flexible with its price changes as its competitors, and the resulting price war has created difficulties for Dell. 2. Lower-priced products typically require more intensive distribution. Ads should emphasize price and value. Given the lower margins and more intense distribution, expect less personal selling and more self-service at the retail level. 3. Though not purely oligopolistic, this industry is characterized by matching price cuts. Class Exercise 2: Demand-Related Pricing Calculations Prompt for students: Complete the following calculations: Price Elasticity of Demand Calculate the price elasticity of demand for a restaurant’s pizza under the following conditions: Old price: $8 New price: $10 Old quantity: 1,000/month New quantity: 900/month Total Revenue: $8,000 Total revenue: $9,000 If the new quantity sold per month were 700 (instead of 900), what would be the price elasticity of demand? Break-even Analysis Assume you are selling pizzas at $8. Your fixed costs (rent, salaries, and utilities) are $4800/month. The food costs and other variable costs are 50 percent of the selling price. What is your break-even point? Answers: Price Elasticity of Demand Price elasticity of demand is a common source of confusion among students. Conceptually, if you raise your prices and total revenue increases, then demand is inelastic. For example, demand for heating oil in the winter would be inelastic because people need to heat their homes regardless of the price. On the other hand, if you raise prices and total revenue declines, then demand is elastic. Prices for durable goods like refrigerators are elastic in the short term because if the price of a product increases, people wait to buy a new appliance until it goes on sale. Many products are elastic in the short-term, but nearly all products are inelastic in the long term. If prices stay high, customers will eventually have to replace goods no matter what the price. Calculations: 10% (change in qty) / + 25% (change in price) = .4 Demand is relatively inelastic (if e < 1.0) for this. If you change the new quantity to 700, then e = 1.2. Break-even Analysis Calculations: Break-even Point = $4,800 / (0.5 x 8) = 1200 units or $9,600. Class Exercise 3: Your Perceptions of Pricing Prompt for students: In this chapter, you learned about various pricing concepts which firms consider when choosing a pricing strategy. In this exercise, you will explore your own perceptions of pricing. Consider the following products/services: • A diamond ring • A haircut • Plumbing services For each product, answer the following questions: 1. What are the non-price attributes of this product? 2. How do these non-price attributes contribute to your perception of the price of the good? 3. How do organizations reinforce the focus on non-price attributes? Answers: For each of the sections, students should focus on internal and external reference points, brand loyalty, product quality, product value, and other factors discussed in the “customers’ interpretation and response” section. Response will vary based on each student’s experience with the product and their expectations. CHAPTER QUIZ 1. Which of the following is not a concern of the practice of price competition? a. Emphasis on price b. Frequent price changes c. Price flexibility d. Focus on product features e. Competitors' price 2. Which of the following products is most likely to have an elastic demand curve? a. Gasoline b. Electricity c. Salt d. Airline tickets for vacation travel e. A textbook required for a course 3. A firm might temporarily sell products below their cost in order to a. increase profits and revenues. b. gain tax benefits and remove excesses. c. raise cash or reduce market share costs. d. match competition or generate cash flow. e. appeal to a price sensitive market. 4. Immediately after the break-even point, a firm starts to a. have revenue. b. experience losses. c. make profits. d. decrease volume. e. reduce costs. Answers to Chapter Quiz: 1. d; 2. d; 3. d; 4. c. SEMESTER PROJECT In this chapter, you learned the basics for understanding pricing concepts and strategies. Understanding how to price is a difficult issue for any business. In this exercise, you will examine the elements you need to consider in thinking about the pricing strategy for your product, you. Step 1: Understand current competitors’ pricing. Using the career resource center and any other on-campus resources, research the salaries of recent graduates with your degree. Then use web-based resources and find the salary of recent graduates with your degree. Step 2: Understand non-price attributes. Identify the criteria used to change the dynamics away from price competition. What features of your product are attractive to the market? Which reduce price sensitivity? Step 3: Understand supply in the marketplace. What is the level of competitive intensity in this market? How many students have graduated from your university with your degree? How many students have graduated with your degree in your region? How many students have graduated with your degree in the U.S.? (Note: This information is often available from the career services center on your campus.) Step 4: Understand demand in the marketplace. Is the number of jobs for students with your degree increasing, decreasing, or remaining stable? What is the projected future demand for these positions? ANSWERS TO ISSUES FOR DISCUSSION AND REVIEW 1. Identify the eight stages in the process of establishing prices. The eight stages in the process of establishing prices are as follows: • Stage 1 is developing a pricing objective that is compatible with the organization’s overall marketing objectives. • Stage 2 entails assessing the target market’s evaluation of price. • In Stage 3, marketers should examine a product’s demand and the price elasticity of demand. • Stage 4 consists of analyzing demand, cost, and profit relationships—it is a necessary step in estimating the economic feasibility of various price alternatives. • Stage 5 involves evaluating competitors’ prices, which helps determine the role of price in the marketing strategy. • Stage 6 requires choosing a basis for setting prices. • Stage 7 is selecting a pricing strategy, or determining the role of price in the marketing mix. • Stage 8 involves determining the final price. This final step depends on environmental forces and marketers’ understanding and use of a systematic approach to establishing prices. 2. How does a return on an investment pricing objective differ from an objective of increasing market share? A return on investment pricing objective is a profit-related objective, and a market share objective is not. Market share pricing objectives will likely lead to higher profits but may result in reduced profits. 3. Why must marketing objectives and pricing objectives be considered when making pricing decisions? It is important that consumers consider the firm to be consistent. The marketing objectives are set in conjunction with the organizational objectives which dictate the firm’s course of action. To tie pricing decisions into this framework helps facilitate the continuity of the firm and contribute to ease of coordination. 4. Why should a marketer be aware of competitors’ prices? A marketer needs to be aware of competitors’ prices to set its price slightly above, equal to, or below those prices. 5. Why do most demand curves demonstrate an inverse relationship between price and quantity? Most demand curves have an inverse relationship between price and quantity because the quantity demanded for most products goes up as the price goes down. Simply put, people want more of things as they become cheaper to buy. This means that the demand for most products is elastic—a change in price causes an opposite change in total revenue. 6. List the characteristics of products that have inelastic demand, and give several examples of such products. Products typically have inelastic demand when people have strong needs and when there are very few substitutes for these products. Examples may include many energy products, like electricity, and medicines. 7. Explain why optimal profits should occur when marginal cost equals marginal revenue. By producing and selling so that marginal costs equal marginal revenue, a firm should obtain optimum profits because, at this point, the production of one additional unit would result in greater costs than the revenue received from an additional unit. This approach to pricing blends the increasing costs and the inefficiencies of production with the price elasticity of the demand schedule. This economic concept gives the false impression that pricing can be highly precise. If revenue and cost remain constant, prices can be set for maximum profits. In practice, revenue and cost are constantly changing. In addition, this approach offers little help in pricing new products. 8. Chambers Company has just gathered estimates for conducting a break-even analysis for a new product. Variable costs are $7 a unit. The additional plant will cost $48,000. The new product will be charged $18,000 a year for its share of general overhead. Advertising expenditures will be $80,000, and $55,000 will be spent on distribution. If the product sells for $12, what is the break-even point in units? What is the break-even point in dollar sales volume? The break-even point equals 40,200 units, or $482,400 in sales. 9. What are the benefits of cost-based pricing? Cost-based pricing is simple to calculate and easy to implement. 10. Under what conditions is cost-plus pricing most appropriate? Cost-plus pricing is most appropriate when actual production costs are difficult to estimate before the product is made. 11. A retailer purchases a can of soup for 24 cents and sells it for 36 cents. Calculate the markup as a percentage of cost and as a percentage of selling price. The markup is 50 percent of cost [(36-24)/24] and 33.3 percent of selling price [(36-24)/36]. 12. What is differential pricing? In what ways can it be achieved? Differential pricing is the charging of different prices to different buyers for the same quality and quantity of product. It can be achieved when the market consists of multiple segments which have different price sensitivities and thus respond differently to price differentials. Differential pricing can occur in several ways, including negotiated pricing, secondary-market discounting, periodic discounting, and random discounting. 13. For what types of products would price skimming be most appropriate? For what types of products would penetration pricing be more effective? Price skimming would be most appropriate for products which have associated research and developmental costs—for example, cameras, computers, calculators, and many technical products. Products introduced with penetration pricing usually have few differentiated advantages. Market penetration is more typical for lower-cost items, such as food products and small household items. 14. Describe bundle pricing, and give three examples using different industries. Bundle pricing is the packaging together of two or more usually complementary products to be sold for a single price. Bundle pricing is commonly found in a number of product categories, including banking, travel, computers, and automobiles with option packages. 15. Why do customers associate price with quality? When should prestige pricing be used? Consumers associate price with quality because of experience and because they have been socialized to believe that the higher the price, the higher the quality. Prestige pricing should be used when the marketer can determine that a higher price is consistent with buyers’ attitudes toward the expected cost of a product. 16. Compare and contrast a trade discount and a quantity discount. A trade discount is a reduction off the list price that a producer gives an intermediary for performing certain functions: selling, transporting, storing, and so forth. It is usually given as a percentage or series of percentages off the list price. A quantity discount is a reduction off the price for buying in quantity. The two discounts are similar insofar as they are incentives to an intermediary from a producer. They help reward the intermediary for actions the producer feels are important. They are different because quantity discounts relate only to the size of the order placed, whereas trade discounts deal with compensation based on functions performed. 17. What is the reason for using the term F.O.B.? The term F.O.B. relates to geographic pricing and stands for “free on board.” It is used to indicate whether the price includes shipping charges. F.O.B. origin pricing means that the price of the goods does not include shipping charges; F.O.B. destination means the producer pays for shipping. ANSWERS TO MARKETING APPLICATIONS 1. As discussed in this chapter, customers interpret and respond to prices in different ways, depending on the type of product, perceptions of product quality, and the customer’s ability to judge product quality independent of the price. Because customers lack the ability to judge product quality, they sometimes used the price of the product as an indicator of product quality. Thus, the price-quality relationship can influence the purchase of some products. For each of the following, indicate whether customers rely heavily, moderately, or hardly at all on the price to judge the quality of a product. a. Airfare in coach b. Appendectomy c. Baby food d. Cell phone service e. Cosmetics f. Dog food g. Electricity h. Gasoline i. Haircut j. Hotel room k. Jewelry l. Tanning salon m. Used car Students’ answers will vary. Their responses will depend on their perceptions of product quality and on the importance of different products to each individual. 2. Price skimming and penetration pricing are strategies that are commonly used to set the base price of a new product. Which strategy is more appropriate for the following products? Explain. a. Short airline flights between cities in Florida b. A Blu-ray player c. A backpack or book bag with a lifetime warranty d. Season tickets for a newly franchised NBA basketball team Price skimming is charging the highest possible price that buyers who most desire the product will pay. It is most appropriate for short airline flights and the backpack with a lifetime warranty because these products offer additional utility to consumers. Penetration pricing is setting prices below those of competing brands to penetrate a market and gain a significant market share quickly. It is most appropriate for Blu-ray players and new NBA team season tickets because these products need to gain market share quickly in order to survive in the market. 3. Price lining is used to set a limited number of prices for selected lines of merchandise. Visit a few local retail stores to find examples of price lining. For what types of products and stores is this practice most common? For what types of products and stores is price lining not typical or feasible? Students’ answers will vary based on the stores they visit and the products they find. In general, price lining simplifies customers’ decision making by holding constant one key variable in the final selection of style and brand within a line. If the prices are attractive, customers will concentrate their purchases without responding to slight changes in price. The most common types of products that have price lining are clothing and some types of food (regular vs. organic groceries). However, it is not common for high-priced items. 4. Professional pricing is used by people who have great skill in a particular field, such as doctors, lawyers, and business consultants. Find examples (advertisements, personal contacts) that reflect a professional pricing policy. How is the price established? Are there any restrictions on the services performed at that price? Students’ answers will vary based on the professions they find. 5. Organizations often use multiple pricing objectives. Locate an organization that uses several pricing objectives, and discuss how this approach influences the company’s marketing mix decisions. Are some objectives oriented toward the short term and others toward the long term? How does the marketing environment influence these objectives? Students’ answers will vary based on their choice of organizations. 6. Develop your analytical and communication skills using the Role-Play Exercises Online at www.cengagebrain.com. Students can visit the website and develop their analytical and communication skills. ANSWERS TO INTERNET EXERCISE T-Mobile T-Mobile has attempted to position itself as a low-cost cellular phone service provider. A person can purchase a calling plan, a cellular phone, and phone accessories at its website. Visit the T-Mobile website at www.t-mobile.com. a. How many different calling plans are available in your area? Students’ answers will vary based on their locations and T-Mobile’s coverage. b. What type of pricing strategy is T-Mobile using on its rate plans in your area? The most common pricing strategies are differential pricing, new-product pricing, product-line pricing, psychological pricing, professional pricing, and promotional pricing. T-Mobile typically uses bait pricing with the intent of selling other high-priced products and services later, but students may find other examples. The company also uses bundle pricing to get customers to buy packages of services. ANSWERS TO DEVELOPING YOUR MARKETING PLAN The information obtained from these questions should assist students in developing various aspects of their marketing plan found in the “Interactive Marketing Plan” exercise at www.cengagebrain.com. 1. Discuss each of the pricing objectives in the chapter. Which pricing objectives will you use for your product? Consider the product life cycle, competition, and product positioning for your target market during your discussion. The chapter discusses seven different pricing objectives and the possible associated action a marketer might take to achieve that objective. Students are to think about their own products and determine which pricing objectives apply. They should consider their product’s life cycle (At what stage is their product?), competition (How many and what kind of competition does their product face?), and product positioning for their target market. 2. Review the various types of pricing strategies. Which of these is the most appropriate for your product? Figure 12.8 shows a number of different pricing strategies. Students should review this list and review what all of the terms mean. After this, they are to decide which pricing strategies are most suitable for their particular product. For example, a student might choose differential pricing if he or she has chosen a stereo system that is being marketed to multiple different market segments consisting of consumers with differing price sensitivities. 3. Select a basis for pricing your product (cost, demand, and/or competition). How will you know when it is time to revise your pricing strategy? Students’ answers will vary depending on their products. COMMENTS ON VIDEO CASE 12: PRICING AT THE FARMERS’ MARKET Summary This case examines the issues associated with direct selling and pricing for farmers at local markets. Selling directly to the public enables farmers to build relationships with local shoppers and encourage repeat buying week after week as different items are harvested. It also allows farmers to realize a larger profit margin than if they sold to wholesalers and retailers because there are no intermediaries. In addition, consumers are willing to pay a higher price for top-quality local products, and even more for products that have been certified organic by a recognized authority. However, competition between farmers, markets, and traditional grocery stores is a factor that influences pricing. Questions for Discussion 1. In the pursuit of profits, how might Urban Farmz use a combination of cost-based, demand-based, and competition-based pricing for the products it sells? Explain your answer. Encourage students to be creative. Cost-based pricing adds a dollar amount or percentage to the cost of the product. Demand-based pricing is based on the level of demand for the product. Competition-based pricing is influenced primarily by competitors’ prices. Urban Farmz should be using all of these strategies and tailoring them to specific products. 2. Urban Farmz wants to price the organic soap at $15.95 per bar, while the soap maker prices the same soap at $14 per bar. What perceptions do you think consumers will have of each price? What recommendations do you have regarding this price difference? Consumers may have different perceptions—they may believe that the Urban Farmz bar is fairly priced since they can buy it directly without ordering it online, or they may believe that Urban Farmz is adding an unfair market. However, given the requests of the soap maker, Urban Farmz should charge the higher price. Consumers may not want to buy online or pay for shipping, and Urban Farmz will still make a profit. 3. Would you recommend that Urban Farmz use promotional pricing at the farmers’ markets where it regularly sells its products? If so, which techniques would you suggest, and why? Students’ answers will vary. Generally, Urban Farmz should not use promotional pricing because it sends a signal to consumers about the quality of their unique products. However, bulk discounts or similar promotions may help stimulate business. Solution Manual for Foundations of Marketing William M. Pride, O. C. Ferrell 9781305361867, 9781305405769, 9780357033760
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