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Chapter Eleven: Pricing Concepts and Strategies: Establishing Value Chapter Objectives 1. Explain what price is and its importance in establishing value in marketing 2. Illustrate how the 5Cs – company objectives, customers, costs, competition, and channel members – influence pricing decisions 3. Describe various pricing strategies and tactics and their use in marketing (e.g. cost-based pricing, competition-based pricing, value-based pricing, psychological pricing, new product pricing, and pricing tactics targeted to consumers and channel members) 4. Summarize the legal and ethical issues involved in pricing Annotated Chapter Outlines PowerPoint Slides Instructor’s Notes The chapter objectives and roadmap are intended to help students understand the content to be discussed. Topic One: What is Price? Price refers to the overall sacrifice a consumer will make to acquire a specific product or service. It is the only marketing mix element that directly generates revenue. Because it is the most challenging of the 4Ps to manage, price rarely gets emphasized. In addition, many managers maintain an overly simplistic view of price. Consumers recognize price as a signal. If a marketer sets a price too high or too low, the wrong message gets sent to the market. Remind students that price refers not just to money but also other costs such as time. Ask students to provide an example of a purchase where they did not consider price. They will probably be hard-pressed to come up with anything, thus making the point. Answer B Topic Two: The Five Cs of Pricing The following slides discuss each C in detail; alternatively, you can use this chart as a basis for a shortened discussion. I. The First C Refers to Company Objectives A. A profit orientation means the firm focuses on target profit pricing, maximizing profits, or target return pricing. 1. Target profit pricing applies when the firm has a particular profit goal. 2. Profit maximizing relies primarily on a mathematical model from economic theory to predict sales and profits. 3. Target return pricing is designed to produce a specific return on investment, usually expressed as a percentage of sales. Each firm has a specific orientation in the marketplace that dominates its pricing strategy. Profit: firms do not use value as a consideration but rather focus on generating a set level of profit from each sale. Ask students: What are the issues with a profit orientation? Answer: The key issue is that it does not take into consideration the value customers have for the product. This may lead to prices being set below and optimal level. B. A sales-oriented firm believes increasing sales helps the firm more than increasing profits. 1. These firms believe overall market share better reflects their success than dollar sales. 2. Adopting this orientation does not necessarily mean setting low prices. Sales: Focus on increasing sales, More concerned with overall market share, Does not always imply low setting low prices Ask Students: Why would firms adopt this orientation? Many first adopt this orientation to establish a position in the market by getting the most price sensitive consumers to change brands. C. With a competitor orientation, firms measure themselves primarily in comparison with the competition. 1. Competitive parity means setting prices that are similar to those of major competitors. 2. Status quo prices change only to meet changes in the prices of the competition. Competitor: Value is not part of this pricing strategy. This strategy is particularly common among smaller firms that lack knowledge or experience in setting prices. Non-market leader firms also use it to signal they are similar to the market leader. Ask students: What are the benefits of a competitor strategy? For example, can a new hotel chain indicate its level of service through price? The answer is yes. In many instances new brands will set price equal to the competitors they wish to be compared with knowing that consumers use reference prices to indicate quality. D. A customer orientation explicitly invokes the concept of value. 1. Perhaps the most difficult pricing strategy. 2. Also the most potentially rewarding. Customer: Focus on customer expectations by matching prices to customer expectations A recent study indicates that a variety of retailers sell one-carat diamonds, but consumers pay vastly different prices at Costco versus Tiffany’s. The diamonds are a commodity; they must meet the same standards and are rated the same. Ask students: Why would a consumer spend thousands more to buy a stone at Tiffany’s? II. The Second C Refers to Customers. For pricing, elasticity is a crucial concept. Ask students: In what circumstances will raising the price NOT result in an increase in revenue? In what circumstances will raising the price result in an increase in revenue? In elastic markets, depending on the level of elasticity, a price increase can increase revenues, but if the increase drives consumers out of the market, demand falls, and a loss of revenue may result. In contrast, in inelastic markets, a price increase almost always increases revenues, because the relationship between price and demand is weak. Pharmaceuticals provide a good example; even if the price of a cancer drug increases, consumers still demand it, so the firm generates more revenue. A. Demand curves and pricing 1. Demand curves show how many units consumers will demand during a specific period of time at different prices. 2. The horizontal axis measures the quantity demanded at a specific price. 3. The vertical axis displays the price options. 4. A demand curve enables firms to examine different prices relative to demand and its overall objectives. 5. Although they usually appear downward sloping, demand curves may take many different shapes. 6. Consumers purchase prestige items for their status rather than their functionality, so demand increases while price increases to a point. This information should be a review from students’ micro-economics coursework, so they should be familiar with the concept, but this discussion applies it in a slightly different way. Knowing demand curve enables to see relationship between price and demand. B. The price elasticity of demand refers to how changes in price affect the quantity of the product demanded. 1. In general, consumers are less sensitive to changes in price for necessary items. 2. A market is elastic (price sensitive) when the price elasticity is <1; that is, a 1% decrease in price produces more than a 1% increase in the quantity sold. 3. A market is inelastic (price insensitive) when a 1% decrease in price results in less than a 1% increase in quantity sold. 4. Consumers tend to be more sensitive to price increases than price decreases. 5. Price elasticity changes at different points on the demand curve. C. Various factors influence the price elasticity of demand 1. As people’s income increases, their spending behaviour changes, known as the income effect. 2. When consumers can substitute other products for the focal brand, elasticity increases because of the substitution effect. Discuss the case of Pete and how the income and substitution effects alter his buying behaviour. As a college student, he prefers a less expensive substitute deodorant, because it demands less of his total income. Ask students: When Pete graduates and gets a high-paying job, will he worry as much about the cost of deodorant? Do you expect him to switch back to Old Spice? Why or why not? 3. Cross-price elasticity represents the percentage change in the demand for Product A compared with the percentage price change for Product B. Just like Kendra, many people buy products without considering the price of necessary peripherals. Kendra is caught in a cross-elasticity trap, because her demand for one product generated demand for the other. Group activity: Brainstorm a list of other products that exhibit cross-price elasticity. III. The Third C Refers to Costs. A. Variable costs, primarily labour and materials, vary with product volume. For services, variable costs are more complex. B. Fixed costs remain essentially the same, regardless of any changes in volume. C. Total costs are the sum of the variable and fixed costs. No discussion of price would be complete without a discussion of cost. The price must at least cover the cost of the item. However, as students may have learned in their finance courses, understanding costs is rarely easy. D. Break-even analyses and decision making 1. Central to a break-even analysis is the determination of the break-even point, at which the units sold generate just enough revenue to equal total costs, and profits are zero. 2. The contribution per unit refers to the price less the variable cost per unit. 3. The break-even point equals the fixed costs divided by the contribution per unit. 4. The target profit point provides an alternative to the break-even point. *You may want to use the Toolkit in the Online Learning Centre associated with this chapter to demonstrate break-even analysis. Any point above the break-even point is profit. Some firms also use a target profit point to identify when sales create a specified target profit rather than zero profit. IV. The Fourth C Represents Competition. A. In an oligopolistic competitive market, only a few firms dominate, and they change their prices in reaction to competition to avoid upsetting an otherwise stable competitive environment. B. Price wars occur when two or more firms compete primarily by lowering their prices. C. Monopolistic competition exists when many firms compete for customers in a given market but differentiate their products. D. In a pure competition scenario, different companies that consumers perceive as substitutes sell commodity products, so price usually depends on the laws of supply and demand. Group activity: List a product or service market that demonstrates each type of competition. Monopoly: Hydroelectric power in most provinces, Microsoft operating system and Office suite. Monopolisitic: many firms competing for customers, e.g. toys Oligopolistic: Cable TV firms such as Rogers or Shaw Pure: Most frequently purchased consumer goods such as soft drinks This you tube ad is for a $5 foot long commercial for Subway (always check link before class). Students will be familiar with this promotion. Ask students if this price promotion has motivated them to visit subway? Ethical Dilemma 11.1: White Label ABM Fees ABM machines run by independent companies add price surcharges to their services above those charged by the banks. Consumers willingly pay these fees because of the convenience offered. V. The Fifth C Refers to Channel Members. A. Manufacturers, wholesalers, and retailers have different perspectives when it comes to pricing strategies. B. Gray markets employ irregular but not necessarily illegal methods by legally circumventing authorized distribution channels to sell goods at prices lower than those intended by the manufacturer. Ask students: Have you ever bought books marked “Instructor Copy: Not for Resale”or“International Student Edition”? Is the bookstore engaging in unethical behaviour? Whom does this grey market benefit? Whom does it hurt? Answer: The purchase of grey market textbooks hurt the publisher and authors. These books do not help recover the costs of all the ancillary packages that are provided to instructors. Other Influences on Pricing I. The Internet Radically Altered Pricing. A. Online markets increase consumer price sensitivity, because consumers can find the best prices for any product quickly. B. Sellers have access to another option for slow selling merchandise other than essentially giving it away: eBay and other online auctions. II. Economic Factors Change. A. As consumers’ disposable incomes and status consciousness increase, they interact to alter pricing. B. Many consumers cross-shop; that is, they buy both premium and low-priced merchandise and patronize both status-oriented and price-oriented retailers. Firms and consumers alike should constantly monitor the economic environment, because economic conditions have a direct impact on pricing. Internet - Ask students: How has online shopping affected firms’ pricing strategies? Answers: Internet shopping has provided people with more information so they have become more sensitive to prices, alternative product options and retailers. Consumers can quickly find and compare prices online and take part in online auctions. Economic Factors - Firms and consumers alike should constantly monitor the economic environment, because economic conditions have a direct impact on pricing. Ask students: How many people cross-shop? Do you believe this practice has influenced the way some firms price their merchandise? Answer: it has made prestige products more expensive and more moderately priced merchandise even less expensive. Topic Three: Pricing Strategies I. Strategies Are Specific to the Offering and the Market. Note the many factors that go into formulating a pricing strategy. Discuss why some strategies choose not to take into consideration the value that consumers place on an offering. This slide sets up the slides that follow. Alternatively, use this chart as a basis for a shortened discussion. II. Cost-Based Methods Determine Price Through Costs. A. Cost-based methods do not recognize the role of consumers. B. Nor do they consider the role of competitors in the marketplace. These simple methods add a percentage amount to the unit cost to derive the price of the good. Ask students: Its simplicity is the major benefit of this method; what are some of the potential problems associated with it? It does not consider what the value the customer places on the product or service. III. Competitor-Based Methods Set Prices Relative to Competitors’. A. With this approach, firms hope to influence consumer perceptions of themselves and competitors. B. When it uses premium pricing, a firm deliberately prices above the level of competing products to appeal to consumers who shop for the best or for whom price does not matter. Group activity: Recall the example of diamonds of identical quality sold at different prices at Costco and Tiffany’s. List possible reasons someone would pay far more for the same item in different stores. Would you do so? Why or why not? IV. Value-Based Methods Focus on Consumers’ Perceptions of Overall Value. A. Sellers must figure out a way to determine consumers’ value perceptions. B. The improvement value method estimates how much more (or less) consumers will pay for a product relative to comparable products. Sellers need to determine consumer value perceptions. 1. Improvement value method – Determine the price that could be charged for a new laptop. Suppose the key features were – weight of the laptop, processing speed, hard drive capacity, and battery life. The improvement value of the new laptop on these four features can be calculated and the benefits weighted to determine a price. 2. Cost of ownership method - Installing solar panels on a home is costly, but the savings over the life of the panels make the cost much lower than traditional electric power. Governments offer incentives that lower the initial investment, in hopes that more homeowners will switch to using solar power. Ask students: What incentive would you need to do so? What method could you use to determine it? Topic: New Product Pricing I. Price Skimming Appeals to Consumers who Pay to Get an Innovation First. A. The product or service must be perceived as breaking new ground and offering new benefits unavailable in alternative products. B. Competitors cannot to enter the market easily; otherwise, competition forces lower prices. C. A significant potential drawback pertains to the relatively high unit costs often associated with producing small volumes of products. D. Consumer discontent can occur if those who purchase early and pay a higher price feel cheated when the prices drop. 2. Penetration Pricing Builds Sales, Share, and Profit by Setting a Low Initial Price. A. This strategy discourages competitors from entering the market because of the small profit margin. B. Unit costs drop significantly as the accumulated volume sold increases along the experience curve, and then sales grow as costs fall and allow further price reductions. C. Firms must have the capacity to satisfy a rapid demand increase. D. Lower price does not signal high quality. E. If some segments of the market are willing to pay more for the product, this strategy is not ideal. Group activity: Develop a list of products that might use price skimming versus penetration pricing. What qualities should a product possess to use a price skimming strategy? For example, Godiva introduced its hot chocolate mix at a price point that was double that of other hot cocoa mixes. How was it able to achieve success with this product? Penetration pricing helps firms build market share for their new products quickly, but consumers must be price elastic for this strategy to work. Ask students: What kind of hot cocoa mix retailer or manufacturer might use this strategy, rather than Godiva’s price skimming approach? Answer: A mass-market cocoa manufacturer like Hershey’s would use a penetration strategy because it wants to be in every possible retail outlet that sells this category. Topic: Psychological Factors Affecting Value-Based Pricing Strategies This slide introduces the subsequent series of slides or can be used as a basis for a shortened lecture. I. Consumers Use Reference Prices. A. Reference price is the price against which buyers compare the actual selling price of the product, which facilitates their evaluation process. B. External reference price is a higher price to which consumers compare the selling price to evaluate the deal, often labelled the “original” or “regular” price. C. Internal reference price is price information stored in memory, such as the last price paid or what the consumer expects to pay for a good. D. A complex relationship exists between external and internal reference prices, such that exposure to different external prices adjusts internal reference prices. Group activity: In groups, list the average prices of the following items: rent on a one-bedroom apartment, a backpack, a washing machine, a mid-size car, a house, a bicycle, and a soda. Compare the price points among groups. Usually, students provide relatively accurate price points for products they use frequently, but their estimates likely vary significantly for the other items. Discuss how they determined these prices. Answer: D II. Choose Everyday Low Pricing (EDLP) versus High/Low Pricing A. Everyday low pricing (EDLP) 1. Companies stress continuous retail prices at a level somewhere between regular, non-sales prices and deep-discount sale prices. 2. Not every product is lower priced, but on average, the total purchase price will be lower at stores featuring EDLP. B. High/low pricing relies on sales promotions and temporarily reduces prices to encourage purchases. C. Each creates value in its own way. 1. EDLP consumers do not have to wait for sales. 2. Some consumers enjoy the challenge of finding the lowest price and prefer high/low pricing. Group activity: Imagine you need an outfit for an upcoming party. You can visit Wal-Mart where you know you will find an EDLP pricing strategy. However, Holt Renfrew is having its semi-annual sale, during which it drastically marks down its usually high prices. Where do you think you will find a better price? Which offers better value? Why? Every day, Groupon.com alerts its users to a deal. The discounts are based in the hundreds of cities worldwide that Groupon serves and offered to site users in those markets. http://www.Groupon.com III. How Odd Prices Started. A. Initially may have been designed to prevent fraud, because the sale had to be rung up to provide change. B. Today, it seems more traditional than practical. C. Consumers may perceive odd numbers as a better value. D. They also perceive odd numbers as implying low quality. Ask students: Do most of the prices you see end in odd numbers? Why? Come up with as many possible explanations as you can that highlight the possible benefits of this system. IV. Consumers Often Infer Quality from Price. A. Not all consumers use this method. B. Consumers without experience with a particular product or brand often use price in their quality judgments. Wine experts know the differences between varieties, but average consumers often have trouble determining what dictates wine prices. Various magazines and organizations provide ratings of wine, which often show that the best wines are not always the most expensive. Topic: Pricing Tactics I. A Pricing Strategy Sets Price in the Long-Term According to the 5Cs. II. Pricing Tactics Focus Short-Term on Select Components of the 5Cs. Until now we have focused on Pricing Strategies. From here we turn to B2B and consumer pricing tactics. Remind students of the difference between strategies and tactics. Pricing Strategy is a long-term approach to setting prices and must balance all 5Cs. Pricing Tactics tend to be short-term methods, and focus on select components, e.g. company objectives, costs, customers, competition, or channel members. Pricing tactics are often used in response to competitive threats. Strategies must balance all 5Cs; tactics tend to focus on select components A. Business-to-business pricing tactics and discounts 1. Seasonal discounts prompt retailers to order merchandise in advance of the normal buying season. Just as consumers do, businesses benefit from seasonal pricing, though with different timing. Most retailers place their Christmas orders in the summer or early fall. Some vendors give them an extra discount to place orders well in advance of the selling season. Ask students: Why would a vendor offer a seasonal discount to retailers? Answer: Because they can plan their production and get the inventory out of their warehouses and into the hands of the retailers. 2. Cash discounts reduce invoice costs if the buyer pays the invoice prior to the end of the discount period. Sellers want outstanding invoices paid as soon as possible and therefore offer discounts to encourage it. Ask students: Would you pay your rent bill early if you received a monetary incentive to do so? 3. Allowances lower final costs in return for specific behaviour. a. Advertising allowances reduce prices to channel members if they feature the manufacturer’s product in advertising and promotional efforts. b. Slotting allowances are fees paid to retailers to get new products into stores or gain more or better shelf space. As the questions at the end of several chapters show, listing allowances have become quite controversial. Group activity: Split the class in half. One half represents smaller producers who believe they are being shut out of grocery markets by listing fees, which can reach $10,000 per store or more. The other half represents grocers, who consider listing fees necessary for their survival in the competitive marketplace. Conduct a debate that presents both sides of this issue. 4. Quantity discounts reduce the price according to the amount purchased. a. Cumulative quantity discounts apply to the amount purchased over a specified time period and usually several transactions. b. Noncumulative quantity discounts are based only on the amount purchased in a single order, which prompts buyers to purchase more merchandise immediately. Ask students: Why would a vendor offer a quantity discount to a retailer? Answer: It helps them plan their production schedule. If may stimulate the retailer to buy more merchandise. It actually costs less on a per unit basis to sell more in one order than less, e.g. transportation expense. 5. Delivery charges use uniform versus zone pricing a. Uniform delivered pricing means the shipper charges one rate, no matter where the buyer is located. b. Zone pricing sets different prices depending on the geographical division of delivery areas. Online shoppers know that delivery can add a significant amount onto cost; the same is true for B2B transactions, in which sellers often vary their delivery charge calculations based on where the customer lives. B. Pricing tactics aimed at consumers This slide can be used as the basis for a shortened lecture or to introduce the subsequent slides. 1. When they use price lining, firms establish floor and ceiling prices for a line of similar products and then set price points within that range to represent distinct quality levels: a. High. b. Medium. c. Low. Ask students to think about a product that offers different levels of quality (e.g. cars, hotels, and clothing). How do firms use price lining to establish differences between the products? Give specific examples. Answer: Mercedes Benz offers the C class for the lower, an E class for the medium, and the S class for the highest price lines. Ralph Lauren offers different lines at different price points as well: Chaps, Polo/Ralph Lauren, Ralph Lauren Black Label, and Purple Label. 2. Price bundling refers to selling more than one product at a single lower price. Price bundling can be used to achieve a variety of objectives. Ask students: What are some examples of commonly price bundled items? Answer: meals at fast-food restaurants, telecommunications services, cruise vacations, grocery store items. 3. Leader pricing attempts to build store traffic by aggressively pricing a regularly purchased item, often at or just above the store’s costs. Ask students: What are some examples of leader priced items? Answer: milk, eggs, coffee, white bread. C. Consumer price reductions This slide can be used as the basis for a shortened lecture or to introduce the following series of slides. 1. Markdowns are reductions of the initial selling price and represent an integral part of high/low pricing. Ask students: Are markdowns used only to take care of buying mistakes? Answer: no, sometimes retailers use markdowns to generate traffic into the store. 2. Quantity discounts for consumers. a. In packaging, larger quantities usually mean lower prices per ounce. b. This per-unit cost encourages consumers to purchase larger quantities each time they buy. Consumers often enjoy quantity discounts, but remind students that bigger packages do not always mean lower unit prices. 3. Seasonal discounts on various products and services attempt to stimulate demand during off-peak seasons. B2B consumers are encouraged to buy early, but for consumers, seasonal discounts also encourage them to buy after the season so sellers can get rid of leftover merchandise. Ask students: Have you ever bought wrapping paper right after Christmas? How much did you save? 4. Coupons and rebates a. With coupons, the retailer handles the discount. b. Coupons prompt consumers to try a product, reward loyal customers, or encourage repurchase. c. Rebates return a portion of the purchase price to the buyer. d. Consumers often find rebates frustrating because they must follow specific rules and meet submission deadlines. Ask students: When did you last use a coupon or a rebate? For what type of product? How much did you save with the rebate/coupon? For what kind of products would you expect to find a coupon or rebate? How do coupons or rebates influence your purchases? Consumers use a lot of coupons to buy cereal, but the high value (generally $.75 or more) of the coupons costs cereal firms a lot of money. When they tried to eliminate coupons and lower the everyday price, consumers wanted the coupons back. With redemption rates for coupons falling, many firms are beginning to wonder if it is time to end the practice altogether. How should firms respond when couponing no longer seems to work to increase sales? Answer: A Topic Four: Legal and Ethical Aspects of Pricing I. Addressing Deceptive and Illegal Price Advertising. A. Deceptive reference prices advertise inflated or just plain fictitious prices. B. Loss leader pricing is similar to leader pricing, but it involves lowering the price below the store’s cost, which is considered to be an unfair competitive practice. C. A bait and switch occurs when sellers advertise items for a very low price, then aggressively pressure customers into purchasing a higher-priced model. D. Predatory pricing attempts to drive competitors out of business by offering very low prices. II. Addressing Price Fixing. A. Horizontal price fixing occurs among competitors that produce and sell competing products but collude to establish a price. B. Vertical price fixing occurs among parties at different levels of the same marketing channel. C. Whereas horizontal price fixing is clearly illegal under the Sherman Antitrust Act, vertical price fixing falls into a gray area and is not always considered illegal. Deceptive/Illegal - Loss leader pricing, Bait and switch Ask students: Have you ever been involved in a bait and switch? Predatory - Prices set low with the intent to drive competitor out of business (See Case in Point which follows for an example.) Price Discrimination - Price discrimination in a B2B setting isn’t always illegal. It is legal to give quantity discounts, to meet competition, and in barter situations. Why are quantity discounts legal? Because it costs less on a per unit basis to sell to customers that buy larger quantities Price Fixing - Ask students: How many products list a manufacturer’s suggested retail price? How many indicate a retail price instead? Note that MSRPs are a form of vertical price fixing; the manufacturer sets the price, and wherever the consumer shops, the price will be the same. However, some retailers argue that this form of price fixing prevents them from passing lower costs on to consumers. Instructor Manual for Marketing Dhruv Grewal, Michael Levy, Shirley Lichti, Ajax Persaud 9780071320382, 9780070984929
