CH-13-14 Designing and Managing Services – Marketing Management: A South Asian Perspective : Chapter Notes

This Document Contains Chapters 13 to 14 Chapter 13 Designing and Managing Services LEARNING OBJECTIVES In this chapter, we will address the following questions: How do we define and classify services, and how do they differ from goods? What are the new service realities? How can we achieve excellence is service marketing? How can we improve service quality? How can goods marketers improve customer-support services? SUMMARY A service is any act or performance that one party can offer to another that is essentially intangible and does not result in the ownership of anything. It may or may not be tied to a physical product. Services are intangible, inseparable, variable, and perishable. Each characteristic poses challenges and requires certain strategies. Marketers must find ways to give tangibility to intangibles; to increase the productivity of service providers; to increase and standardize the quality of the service provided; and to match the supply of services with market demand. Marketing of services faces new realities in the 21st Century due to customer empowerment, customer coproduction, and the need to satisfy employees as well as customers. In the past, service industries lagged behind manufacturing firms in adopting and using marketing concepts and tools, but this situation has now changed. Achieving excellence in service marketing calls not only for external marketing, but also for internal marketing to motivate employees, as well as interactive marketing to emphasize the importance of both “high tech” and “high touch.” Top service companies excel at the following practices: a strategic concept, a history of top-management commitment to quality, high standards, self-service technologies, systems for monitoring service performance and customer complaints, and an emphasis on employee satisfaction. Superior service delivery requires managing customer expectations and incorporating self-service techniques. Customers’ expectations play a critical role in their service experiences and evaluations. Companies must manage service quality by understanding the effects of each service encounter. Even product-based companies must provide postpurchase service. To provide the best support, a manufacturer must identify the services customers value most and their relative importance. The service mix includes both presale services (facilitating and value-augmenting services) and postsale services (customer service departments, repair and maintenance services). OPENING THOUGHT The teaching of “services marketing” can pose a challenge to the instructor by the very nature of a “service”—its intangibility, inseparability, variability, and perishability. Challenges to the instructor in teaching this course lies in connecting these concepts to the students in ways that they will relate to and understand. Students use services everyday, in their role as a student, it means that they are receiving a service— instruction. The instructor is encouraged to use the example of “instruction” or the university setting to demonstrate the four dimensions of services that differentiates it from a physical product: intangible, inseparable, variability, and perishability. Most students will understand that a service cannot be felt, touched, or inventoried; some students will not fully understand the inter connectiveness between the service provider and the service “receiver” or consumer. Students may have some difficulty in conceptualizing the service dimensions of reliability, responsiveness, assurance, empathy, and tangibles as part of the service marketing dimensions. The instructor is encouraged to use multiple examples of excellent service companies, guest speakers, and personal or student real life examples to illustrate the challenges facing the marketing of services to the public. The interaction or role that the customer plays in the delivery of a service may pose a barrier because many students (and of course actual consumers) do not fully understand their part in the service process or maximize their participation in the process. This topic is a good one for an in-class discussion or outside assignment. Students, as well as instructors, can and do like to tell service stories (positive or negative) that can illustrate and/or demonstrate good and bad service marketing. TEACHING STRATEGY AND CLASS ORGANIZATION PROJECTS At this point in the semester-long project, those students who have selected a “service” idea for the marketing plan must submit their offering. Students whose project is a “product based” component do not have anything to submit for this chapter. Using the information on marketing research covered in this text, ask the students to prepare a teaching SERVQUAL® form to be administered in all the classes taught in your department. This SERVQUAL survey should focus on evaluating the student’s understanding of their role in the service delivery process of teaching. If your college or university has a standardized form for evaluating students’ perceptions of learning, ask the students to compare and contrast these two measures. Where are they different and where are they similar? Marketing Plan: All marketers need to develop a service strategy when preparing their marketing plans. Marketers of intangible products must consider how to manage customer expectations and satisfaction. Marketers of tangible products must create suitable support services. Get students to plan product support services for their product or service. The following questions will help them map their service strategy: What support services do buyers want and need? Consider what competitors are doing in this area. How can they identify and manage gaps between expected and perceived service to satisfy customers? What post-sale services must they make available to customers? What internal marketing do they need to do to implement their service strategy? Get students to summarize their recommendations in a written marketing plan or enter the information in the Product Offering and Service section of the Marketing Mix heading in Marketing Plan Pro. ASSIGNMENTS As the opening vignette indicated, part of Cirque du Soleil’s success comes from a company culture that encourages artistic creativity and innovation and carefully safeguards the brand. Get students to research and examine the company’s mission statement, beliefs, goals, values etc., and determine if some of it may be applied to other types of businesses. We all have “service failure” stories to tell. As a matter of fact, most people love to tell about the time that such and such firm provided sub-par service to us as consumers. Sometimes these stories are humorous and other times they are sad. Ask the students to think about such stories and prepare to tell these stories in class. These stories can either be their own stories or that of a close friend or family member. In preparing to recount the story line, students should first analyze the incident in terms of the concepts and tenants presented in this chapter. For example, the restaurant that did not address a customer’s “cold food” is a service failure. However, was that service failure due to insufficient training, inadequate hiring practices, or an inability of the restaurant to monitor customer expectations? Students should come to class prepared to identify (as close as possible) the causes of the service failure. Search and experience qualities are two characteristics of service providers. Yet each provides consumers with differing “clues” as to the competency of the service provider. In this assignment, students are to identify two different service providers—one that is high in search qualities and one that is high in experience qualities. Using the consumer expectancy-value model and non-compensatory models of consumer choice covered in Chapter 6 of this text, students should outline their understanding of how consumers select a service high in search qualities and high in credence qualities. In the Marketing Memo entitled, “Assessing E-Service Quality,” the authors identify a 14-item scale that forms the basic building blocks of a “compelling online experience.” Students should be directed to find Web sites (one or more) that meet all or a majority of these 14 items and those that do not meet a majority of the items mentioned. In preparing their papers, students should include rationale for their characterizations of these Web sites. In the Marketing Memo entitled, “Recommendations for Improving Service Quality,” the authors Berry, Parasuraman, and Zeithaml, offer 10 lessons that they maintain are essential for improving service quality across service industries. Individually or in small groups, have the students analyze their Department, College, or University against these 10 criteria and list their recommendations for improving. END-OF-CHAPTER SUPPORT MARKETING DEBATE—Is Service Marketing Different From Product Marketing? Some service marketers vehemently maintain that service marketing is fundamentally different from product marketing and that different skills are involved. Some traditional product marketers disagree, saying “good marketing is good marketing.” Take a position: ‘Product and service marketing are fundamentally different’ versus ‘Product and service marketing are highly related’. Pro: Marketing is marketing. Consumers buy a product or use a service to answer a particular need or want. The customers’ value hierarchy: The customers’ decision-making process and their own consumption system does not change when purchasing a service versus a product. How the consumer comes to understand the core benefit, potential product, or the functionality of the service is based upon branded marketing theory. The difference between marketing a service versus marketing a product lies in the execution of the marketing process for the service. Product, place, price, and promotion concepts are still valid—albeit with some changes in either their weight in the consumer-decision process or their means of communication to the consumers. Con: The dimensions that distinguish a product from a service vary: intangibility of the service (that it does not contain physical properties for the consumer to feel, touch, smell, or “try-on”). The inseparability of the service provider from the consumer; the variability of service from encounter to encounter; and the fact that the service is perishable all create new and different marketing challenges for the service marketer. The service marketer must make an “intangible” tangible, make variability consistent, tell the customer that you, the customer, have a role in this process, participate in the successful outcome, and that the service marketer must adjust for fluctuating demand and supply timing, are different from product marketers. Finally, the service marketer must ensure that customer expectations are matched by customer perceptions after the service is performed. The service provider can either communicate lower expectations for their customers or develop processes to deliver to the customers’ expectations each time. Less than a 100 percent “match” between expectations and performance for the service provider leads to dissatisfied consumers who use past experiences, word-of-mouth (mouse), and physical clues with assigned higher degree of importance than for physical products. Marketing Discussion Colleges, universities and other educational institutions can be classified as service organizations. How can you apply the marketing principles developed in this chapter to your school? Do you have any advice as to how they could become better service marketers? Suggested Response: Student answers will differ. However, the following marketing principles developed in the chapter were: A service differs from a product in its intangibility, inseparability, variability, and perishability. Service marketing must be done holistically and calls for external, internal, and interactive marketing. Service marketers must manage service quality by understanding the effects of each service encounter. To brand a service, the company must differentiate its brand through primary and secondary service features and often employs multiple brand elements. Service companies that excel in service have the following practices: A strategic concept toward service, top-management’s commitment to quality, high standards, self-serving technologies, systems to monitor service performance and customer complaints, and an emphasis on employee satisfaction. Product-based firms must provide postpurchase service by identifying the “services” customers value the most and the relative importance of each. Colleges and universities can apply marketing principles by focusing on the unique value propositions of their programs, leveraging student testimonials, and optimizing their digital presence. To enhance service marketing, they could improve personalization in communication, streamline application processes, and enhance student support services to align with expectations and deliver consistent, high-quality experiences. Marketing Lesson: BANYAN TREE HOTELS AND RESORTS In terms of the four distinctive service characteristics, how would you describe Banyan Tree Hotels and Resorts? Suggested Answer: Intangibility—Positioned as a “Sanctuary for the Senses”, “intimacy and romanticism”, staff are empowered to deliver customer satisfaction. Inseparability—BTHR empowers its employees to vary their service offering from resort to resort according to local culture and practices. Variability—Service standards are specified not so much in technical terms such as times and quantities, but rather in terms of customer satisfaction; staff training varies because of cultural considerations. Perishability—BTHR feels that many service problems arise from language barrier, such as employees misunderstanding what the guests are asking. To minimize this, it hires the right English-proficient employees. Get students to explain how the four distinctive service characteristics and their explanations may overlap in this case. Banyan Tree Hotels and Resorts exemplifies high customization with personalized service and exclusive experiences, tangible offerings through luxurious accommodations and spa services, intangibility by focusing on unique experiences and emotions, and perishability through time-sensitive bookings and limited availability of premium services. BTHR gives employees empowerment. Can customer empowerment also be practiced at BTHR? Why or why not? Give examples. Suggested Answer: Yes, customer empowerment can also be practiced at BTHR. By listening to customers’ various product or service requests and trying the best to fulfill them. E.g A customer may find a particular painting in the room very beautiful and makes a request to purchase it, service staff should at the very least check on the possibility of such a purchase and not give an immediate negative response since the request is outside the “norm”. Yes, customer empowerment can be practiced at Banyan Tree Hotels and Resorts through personalized service options, customer feedback mechanisms, and interactive experiences like cooking classes or local tours, enhancing guest satisfaction and loyalty through active participation in their stay decisions. Can BTHR service quality be duplicated by other resorts? Why or why not? Suggested Answer: No service quality has the four distinctive service characteristics of Intangibility, Variability, Inseparability and Perishability. Hence, other resorts may match it through training of staff but it cannot be copied exactly or duplicated. Banyan Tree Hotels and Resorts' service quality stems from its unique blend of personalized luxury, environmental sustainability, and cultural authenticity, making it difficult to replicate fully without similar commitment and investment in these core values and operational philosophies. Marketing Lesson: SINGAPORE AIRLINES What are SIA’s Points-of-Parity (POP) and Points-of-Differentiation (POD)? Suggested Answer: POP—Positions itself as an excellent service provider, Internet check in. POD – Consistent high service standard extends to all classes of passengers, not just First Class passengers, the iconic Singapore Girl, ranked 18th in Fortune’s list of most-admired companies in 2011, regular global recognition as the best airline. SIA's Points-of-Parity (POP) include safety, reliability, and basic service standards expected in the airline industry. Points-of-Differentiation (POD) for SIA encompass exceptional in-flight service, luxurious amenities, and strong brand reputation for premium travel experiences. In what ways does SIA have the “wow effect”? What can it do to sustain this “wow effect”? Suggested Answer: Famous for pampering passengers, SIA continually strives to create a “wow effect” and surpass customers’ expectations. It was the first to launch individual video screens at airplane seats, telephones in every seat, cutting-edge gaming and inflight entertainment, “Book the Cook” service for special meals in First and Business Classes, and Internet check-in. Thanks to the first-of-its-kind $1 million simulator SIA built to mimic the air pressure and humidity inside a plane, the carrier found that taste buds change in the air and that, among other things, it needed to cut back on spices in its food. SIA places a high value on training; its “Transforming Customer Service (TCS)” program includes staff in five key operational areas: cabin crew, engineering, ground services, flight operations, and sales support. SIA creates the "wow effect" through meticulous attention to detail in service, innovative cabin designs, gourmet dining options, and personalized customer care. To sustain this, SIA should continue investing in passenger comfort, embrace technological advancements in in-flight entertainment and connectivity, and maintain consistent high standards of service across all touchpoints. Low-cost carriers have entered Asia in a big way in recent years. What can SIA do to ensure that passengers are willing to pay a premium for its service relative to the much cheaper low-cost carriers especially for short-haul flights where service is less of a significant factor? Suggested Answer: Students’ answers will vary. What Singapore Airlines needs to do to excel in this competitive era is to “justify” its premium fares by renewing and reinvesting in its success formula – an unrivalled product and service offering, a strong network, a young fleet, overhaul its cabin offerings with the addition of a roomier economy class. To justify premium pricing over low-cost carriers on short-haul flights, SIA can emphasize superior comfort, convenience, and reliability, offer bundled amenities like baggage allowance and seat selection, and differentiate with loyalty programs or frequent flyer benefits to enhance perceived value and customer loyalty. What do you think of the use of the Singapore Girl as its symbol of service excellence? Suggested Answer: As iconic as the Singapore Girl is, short haul travelers in particular may be less inclined to pay a premium fare for a symbol. Comfort remains a priority for most airline travelers in this age of high fuel prices and many would substitute the Singapore Girl for another airline with comparable service quality. The use of the Singapore Girl as a symbol of service excellence has been effective for SIA, portraying grace, hospitality, and professionalism, enhancing brand recognition and customer loyalty through a distinctive and culturally resonant icon. DETAILED CHAPTER OUTLINE As product companies find it harder and harder to differentiate their physical products, they turn to service differentiation. Many find significant profitability in delivering superior service, whether that means on-time delivery, better and faster answering of inquiries, or quicker resolution of complaints. Top service providers know these advantages well and also how to create memorable customer experiences. THE NATURE OF SERVICES In Asia, the service sector makes up a large portion of various countries’ GDP, varying from 40 to 80 percent. This percentage has been increasing over the years in most Asian countries. SERVICE INDUSTRIES ARE EVERYWHERE Government sector Private nonprofit sector Business sector Manufacturing sector Retail sector A service is any act or performance that one party can offer to another that is essentially intangible and does not result in the ownership of anything. Its production may or may not be tied to a physical product. Manufacturers, distributors, and retailers can provide value-added services or simply excellent customer service to differentiate themselves. CATEGORIES OF SERVICE MIX The service component can be a minor or major part of the total offering. We distinguish five categories of service offerings: Pure tangible goods Tangible good with accompanying services Hybrid Major service with accompanying minor goods and services Pure service Services vary as to whether they are: Equipment-based People-based Service companies can choose among different processes to deliver their service. Some services require the client’s presence and some do not. Services differ as to whether they meet a personal need or a business need. Service providers typically develop different marketing programs for personal and business markets. Service providers differ in their objectives (profit and nonprofit) and ownership (private or public). Goods high in search qualities—characteristics the buyer can evaluate before purchase. In the middle are goods and services high in experience qualities—characteristics the buyer can evaluate after purchase. Goods and services high in credence qualities—characteristics the buyer normally finds hard to evaluate even after consumption and that comprise most services. Because services are generally high in experience and credence qualities, there is more risk in purchase. This has several consequences: Service consumers generally rely on word of mouth rather than advertising. Service consumers rely heavily on price, personnel, and physical cues to judge quality. Service consumers are highly loyal to service providers that satisfy them. Because of the switching costs involved, much consumer inertia can exist. It can be challenging to entice a customer away from a competitor. DISTINCTIVE CHARACTERISTICS OF SERVICES Services have four distinctive characteristics that greatly affect the design of marketing programs: intangibility, inseparability, variability, and perishability. Intangibility Unlike physical products, services cannot be seen, tasted, felt, heard, or smelled before they are bought. To reduce uncertainty, buyers will look for evidence of quality. They will draw inferences about quality from the place, people, equipment, communication material, symbols, and price that they see. Therefore, the service provider’s task is to “manage the evidence,” to “tangibilize the intangible.” Service companies can try to demonstrate their service quality through physical evidence and presentation. Service marketers must be able to transform intangible services into concrete benefits. Table 13.1 measures brand experiences in general along sensory, affective, behavioral, and intellectual dimensions. Because there is no physical product, the service provider’s facilities—its primary and secondary signage, environmental design and reception area, employee apparel, collateral material, and so on—are especially important. Inseparability Services are typically produced and consumed simultaneously. Because the client is also present as the service is produced, provider-client interaction is a special feature of service marketing. Several strategies exist for getting around this limitation: Work with larger groups Work faster Train more service providers Variability Because they depend on who provides them and when and where they are provided, services are highly variable. There are three steps service firms can take to increase quality control: 1) Invest in good hiring and training procedures. 2) Standardize the service-performance process throughout the organization. 4) Monitor customer satisfaction. Figure 13.2. Blueprint for Overnight Hotel Stay Perishability Services cannot be stored. When demand fluctuates service firms have problems. Several strategies can produce a better match between supply and demand. On the demand side: 1) Differential pricing Non-peak demand Complementary services Reservation systems On the supply side: Part-time employees Peak-time efficiency Increased consumer participation Shared services Facilities for future expansion THE NEW SERVICE REALITIES At one time, service firms lagged behind manufacturing firms in their use of marketing because they were small or professional businesses that did not use marketing, or faced large demand or little competition. This has changed. Some of the most skilled marketers are now service firms. A SHIFTING CUSTOMER RELATIONSHIP Not all companies, however, have invested in providing superior service, at least not to all customers. Marketing Insight: The Japanese Philosophy of Service Customer service, product quality, and after-sales service are the three pillars of marketing in Japan (refer to p. 462). Customer Empowerment Customers are becoming more sophisticated about buying product-support services and are pressing for “services unbundling.” They may want separate prices for each service element and the right to select the elements they want. Customers also increasingly dislike having to deal with a multitude of service providers handling different types of equipment. Some third-party service organizations now service a greater range of equipment. Most important, the Internet has empowered customers by letting them vent their rage about bad service—or reward good service—and send their comments around the world with the click of a mouse. Most companies respond quickly, some within an hour. More important than simply responding to a disgruntled customer, however, is preventing dissatisfaction from occurring in the future. That may mean simply taking the time to nurture customer relationships and giving customers attention from a real person. Customer Co-Production The reality is that customers do not merely purchase and use a service; they play an active role in its delivery. Their words and actions affect the quality of their service experiences and those of others, and the productivity of frontline employees. Preventing service failures from ever happening to begin with is crucial, as service recovery is always challenging. One of the biggest problems is attribution—customers often feel the firm is at fault or, even if not, that it is still responsible for righting any wrongs. Figure 13.3 displays the four broad categories of root causes for customer failures, although there often are multiple causes at work. Solutions come in all forms, as illustrated by some of the examples. Redesign processes and redefine customer roles to simplify service encounters. Incorporate the right technology to aid employees and customers. Create high-performance customers by enhancing their role clarity, motivation, and ability. Encourage “customer citizenship” where customers help customers. SATISFYING EMPLOYEES AS WELL AS CUSTOMERS Excellent service companies know that positive employee attitudes will promote stronger customer loyalty. Instilling a strong customer orientation in employees can also increase their job satisfaction and commitment, especially if they have high customer contact. Employees thrive in customer-contact positions when they have an internal drive to pamper customers, accurately read customer needs, develop a personal relationship with customers, and D) deliver quality service to solve customers’ problems. Given the importance of positive employee attitudes to customer satisfaction, service companies must attract the best employees they can find. They need to market a career rather than just a job. They must design a sound training program and provide support and rewards for good performance. They can use the intranet, internal newsletters, daily reminders, and employee roundtables to reinforce customer-centered attitudes. Finally, they must audit employee job satisfaction regularly. ACHIEVING EXCELLENCE IN SERVICES MARKETING Marketing Excellence Marketing excellence with services requires excellence in three broad areas: external, internal, and interactive marketing (see Figure 13.4). External marketing describes the normal work of preparing, pricing, distributing, and promoting the service to customers. Internal marketing describes training and motivating employees to serve customers well. The most important contribution the marketing department can make is arguably to be “exceptionally clever in getting everyone else in the organization to practice marketing.” Interactive marketing describes the employees’ skill in serving the client. Clients judge service not only by its technical quality (Was the surgery successful?), but also by its functional quality (Did the surgeon show concern and inspire confidence?). BEST PRACTICES OF TOP SERVICE COMPANIES In achieving marketing excellence with their customers, well-managed service companies share a strategic concept, a history of top-management commitment to quality, high standards, profit tiers, and systems for monitoring service performance and customer complaints. A) Strategic Concept Top service companies are “customer obsessed.” They have a clear sense of their target customers and their needs and have developed a distinctive strategy for satisfying these needs. B) Top-Management Commitment Companies such as Singapore Airlines, Giordano, Marriott, and Disney have a thorough commitment to service quality. Their managements look not only at financial performance on a monthly basis, but also at service performance. C) High Standards The best service providers set high service-quality standards. Profit Tiers Firms have decided to raise fees and lower service to those customers who barely pay their way, and to coddle big spenders to retain their patronage as long as possible. Marketing Memo: The Seven Deadly Sins of Service Management Giordano is arguably Asia’s most successful home-grown clothing retail chain. Outstanding service is a cornerstone for Giordano’s success. Peter Lau, its chairman and CEO, outlined seven cardinal errors top management of service businesses should note and avoid (refer to p. 467). E) Monitoring Systems Top firms audit service performance, both their own and their competitors, on a regular basis. They collect voice of the customer (VOC) measurements to probe customer satisfiers and dissatisfiers. Services can be judged on customer importance and company performance. Importance-performance analysis is used to rate the various elements of the service bundle and identify what actions are required. Table 13.3 shows how customers rated 14 service elements (attributes) of an automobile dealer’s service department on importance and performance. The ratings of the 14 elements are displayed in Figure 13.5 and divided into four sections. Satisfying Customer Complaints Every complaint is a gift if handled well. Companies that encourage disappointed customers to complain — and also empower employees to remedy the situation on the spot — have been shown to achieve higher revenues and greater profits than companies that do not have a systematic approach for addressing service failures. Getting frontline employees to adopt extra-role behaviors, and to advocate the interests and image of the firm to consumers, as well as take initiative and engage in conscientious behavior in dealing with customers, can be a critical asset in handling complaints. Companies also are increasing the quality of their call centers and their customer-service representatives (CSRs). DIFFERENTIATING SERVICES Finally, customers who view a service as fairly homogeneous care less about the provider than about the price. Marketing excellence requires service marketers to continually differentiate their brands so they are not seen as a commodity. Primary and Secondary Service Options Marketers can differentiate their service offerings in many ways, through people and processes that add value. What the customer expects is called the primary service package. The provider can add secondary service features to the package. In the hotel industry, various chains have introduced such secondary service features as merchandise for sale, free breakfast buffets, and loyalty programs. Innovation with Services Many companies are using the Web to offer primary or secondary service features that were never possible before. MANAGING SERVICE QUALITY The service quality of a firm is tested at each service encounter. Service outcome and customer loyalty are influenced by a host of variables. One study identified more than 800 critical behaviors that cause customers to switch services. These behaviors fall into eight categories (see Table 13.3). Another study honed in on the service dimensions that customers would most like companies to measure. As Table 13.4 shows, knowledgeable frontline employees and the ability to achieve one-call-and-done rose to the top. Marketing Memo: Recommendations for Improving Service Quality Pioneers in conducting academic service research, Berry, Parasuraman, and Zeithaml offer 10 lessons they maintain are essential for improving service quality across service industries (refer to p. 473). Managing Customer Expectations Customers form service expectations from many sources, such as past experiences, word of mouth, and advertising. In general, customers compare the perceived service with the expected service. If the perceived service falls below the expected service, customers are disappointed. If the perceived service meets or exceeds their expectations, they are apt to use the provider again. Successful companies add benefits to their offering that not only satisfy customers but also surprise and delight them. Delighting customers is a matter of exceeding expectations. The service-quality model, shown in Figure 13.6, identifies five gaps that cause unsuccessful delivery: Gap between consumer expectations and management perception. Gap between management perception and service-quality specification. Gap between service-quality specifications and service delivery. Gap between service delivery and external communications. Gap between perceived service and expected service. Based upon this service-quality model, these researchers identified the following five determinants of service quality, in order of importance: Reliability Responsiveness Assurance Empathy Tangibles Based on these five factors, the researchers developed the 21-item SERVQUAL scale (See Table 13.5). They also note that there is a zone of tolerance or range where consumer perceptions on a service dimension would be deemed satisfactory, anchored by the minimum level consumers would be willing to accept and the level that customers believe can and should be delivered. The service-quality model in Figure 13.6 highlights some of the gaps that cause unsuccessful service delivery. Increasing customer expectations of what the firm will deliver can lead to improved perceptions of overall service quality. Decreasing customer expectations of what the firm should deliver can also lead to improved perceptions of overall service quality. Much work has validated the role of expectations in consumers’ interpretations and evaluations of the service encounter and the relationship they adopt with a firm over time. Consumers are often forward-looking with respect to their decision to keep or switch from a service relationship. Any marketing activity that affects current or expected future usage can help to solidify a service relationship. With continuously provided services, such as public utilities, health care, financial and computing services, insurance, and other professional, membership, or subscription services, customers have been observed to mentally calculate their payment equity—the perceived economic benefits in relationship to the economic costs. In other words, customers ask themselves, “Am I using this service enough, given what I pay for it?” Long-term service relationships can have a dark side. An ad agency client may feel that over time the agency is losing objectivity, becoming stale in its thinking, or beginning to take advantage of the relationship. INCORPORATING SELF-SERVICE TECHNOLOGIES (SSTS) As with products, consumers value convenience in services. Many person-to-person interactions are being replaced by self-service technologies. Not all SSTs improve service quality, but they have the potential of making service transactions more accurate, convenient, and faster for the consumer. Marketing academics and consultants Jeffrey Rayport and Bernie Jaworski define a customer-service interface as any place at which a company seeks to manage a relationship with a customer, whether through people, technology, or some combination of the two. Some companies have found that the biggest obstacle is not the technology itself, but convincing customers to use it, especially for the first time. MANAGING PRODUCT-SUPPORT SERVICES No less important than service industries are product-based industries that must provide a service bundle. Manufacturers of equipment—small appliances, office machines, tractors, mainframes, airplanes—all have to provide product-support services. Product support service is becoming a major battleground for competitive advantage. Marketing Memo: Assessing E-Service Quality Defining service quality for online services included the core dimensions of regular service quality were: efficiency, fulfillment, reliability, and privacy. IDENTIFYING AND SATISFYING CUSTOMER NEEDS The company must define customer needs carefully in designing a service support program. Customers have three specific worries: They worry about reliability and failure frequency. They worry about downtime. They worry about out-of-pocket costs. A buyer considers all of these factors in choosing a vendor. The buyer tries to estimate the life-cycle cost that is the product’s purchase cost plus the discounted cost of maintenance and repair less the discounted salvage value. Buyers ask for hard data in choosing among vendors. The importance of reliability, service dependability, and maintenance vary. Where reliability is important, manufacturers or service providers can offer guarantees to promote sales. To provide the best support, a manufacturer must identify the services customers value most and their relative importance. For expensive equipment, manufacturers offer facilitating services such as installation, staff training, maintenance and repair services, and financing. They may also add value-augmenting services, which include warranties, guarantees, and trade-in allowances. As another alternative, many companies offer service contracts (also called extended warranties), in which sellers agree to provide free maintenance and repair services for a specified period of time at a specified contract price. See Figure 13.7 for the strategies of different service companies. POST SALE SERVICE STRATEGY The quality of customer service departments varies greatly. In providing service, most companies progress through a series of stages from simply transferring customer calls to the appropriate department for action to those companies eager to receive customer requests who handle them expeditiously. Customer-Service Evolution Manufacturers usually start by running their own parts-and-service departments. They want to stay close to the equipment and know its problems. They also find it expensive and time consuming to train others and discover they can make good money from parts and service if they are the only supplier and can charge a premium price. The Customer-Service Imperative Customer-service choices are increasing rapidly, however, and equipment manufacturers increasingly must figure out how to make money on their equipment, independent of service contracts. Chapter 14 Developing Pricing Strategies and Programs LEARNING OBJECTIVES In this chapter, we will address the following questions: How do consumers process and evaluate prices? How should a company set prices initially for products or services? How should a company adapt prices to meet varying circumstances and opportunities? When should a company initiate a price change? How should a company respond to a competitor’s price change? CHAPTER SUMMARY Despite the increased role of nonprice factors in modern marketing, price remains a critical element of the marketing mix. Price is the only element that produces revenue; the others produce costs. In setting pricing policy, a company follows a six-step procedure. It selects its pricing objective. It estimates the demand curve, the probable quantities it will sell at each possible price. It estimates how its costs vary at different levels of output, at different levels of accumulated production experience, and for differentiated marketing offers. It examines competitors’ costs, prices, and offers. It selects a pricing method. It selects the final price. Companies do not usually set a single price, but rather a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, and other factors. Several price-adaptation strategies are available: (1) geographical pricing; (2) price discounts and allowances; (3) promotional pricing; and (4) discriminatory pricing. Firms often need to change prices. A price decrease might be brought about by excess plant capacity, declining market share, a desire to dominate the market through lower costs, or economic recession. A price increase might be brought about by cost inflation or overdemand. Companies must carefully manage customer perceptions in raising prices. Companies must anticipate competitor price changes and prepare a contingent response. A number of responses are possible in terms of maintaining or changing price or quality. The firm facing a competitor’s price change must try to understand the competitor’s intent and the likely duration of the change. Strategy often depends on whether a firm is producing homogeneous or nonhomogeneous products. A market leader attacked by lower-priced competitors can seek to better differentiate itself, introduce its own low-cost competitor, or transform itself more completely. OPENING THOUGHT Students should have a good understanding of “price” in their role as consumers. The instructor is encouraged to expand the student’s definition of “a price” by using examples of different pricing structures (cell phone plans for example), promotional pricing, geographical pricing, and price discrimination. An area for some misunderstanding for students new to marketing is how the firm reviews competitor’s reactions to price changes. Students will have some degree of difficulty in assuming the “role” of a competitor and formulating defensive and/or offensive plans to price changes. Sufficient classroom time should be spent in clarifying these roles. Discriminatory pricing is also an area that students new to marketing can have some difficulty understanding for the first time. Although discriminatory pricing is not illegal, per se, the distinctions are sometimes porous between the two. TEACHING STRATEGY AND CLASS ORGANIZATION PROJECTS At this point in the semester-long marketing plan project, students should be prepared to hand in their pricing strategy decisions for their fictional product/service. In reviewing this section, the instructor should make sure that the students have addressed all or most of the material concerning pricing covered in this chapter. Consumer perceptions of prices are also affected by alternative pricing strategies. Marriott Hotels, for example, has different brands for differing price points. Building upon the Marriott example, students are to scan the environment to find examples of a company whose pricing strategy is closely tied to its branding strategy. Caution: students may want to list just the different price points in the same company such as Ford automobiles. What this project is designed to accomplish, is that students should note that the Lincoln line of cars are priced at a premium to the Ford and Mercury divisions. Good students will also have researched the actual percentage difference between the three divisions. Marketing Plan: Pricing is a critical element in any company’s marketing plan, because it directly affects revenue and profit goals. Effective pricing strategies must consider costs as well as customer perceptions and competitor reactions, especially in highly competitive markets. Get students to review their SWOT Analysis and Competition Analysis. Also, to think about the markets they are targeting and the positioning they want to achieve. Then, answer the following questions about pricing: What should the primary pricing objective be? Why? Are customers likely to be price-sensitive? Is demand elastic or inelastic? What are the implications of the answers for pricing decisions? What price adaptations such as discounts, allowances, and promotional pricing should be included in the marketing plan? Get students to document their pricing strategies and programs in a written marketing plan or type them into the Marketing Mix section of Marketing Plan Pro. ASSIGNMENTS Marketers recognize that consumers often actively process price information, interpreting prices in terms of their knowledge from prior purchasing experience, formal communications, informal communications, point-of-purchase, or online resources. Purchase decisions are based on how consumers perceive prices and what they consider to be the current actual price—not the marketer’s stated price. In small groups, ask the students to choose a service good, such as education, legal advice, tax advice, or other such services, and have them map out their perception of prices and what they consider to be the current actual price. Finally, students should compare and contrast their perceptions with the stated or published prices for these services. In completing this assignment, students should explain the differences between perception and stated prices in terms of consumer buying behavior models from Chapter 6 of this text. Many consumers use price as an indicator or quality. As a group assignment, students should choose a product produced by a firm. Subsequently, the students should conduct a small research project (utilizing the material learned from Chapter 4) and either, confirm, or deny this relationship for the chosen product. For example, do more women or men rely on price as an indicator of quality for product X? If there is a difference, what is the quantifiable difference in terms of marketing research data? Does this difference suggest that marketers must or can revise, or revamp price clues to reach their target market? Katherine Heires in Business Week 2.0, October 2006, wrote “Why it Pays to Give Away the Store.” Either in small groups or individually, have the students read Ms. Heires article and comment on the validity/invalidity of these nine suggestions as being applicable to key service companies. Table 14.1 lists some possible consumer reference prices and students should comment on whether or not these consumer reference prices are applicable today. Is this list inclusive or are there new reference points caused by the increased use of such Web sites like eBay or Craigslist? Table 14.2 lists nine factors that the authors contend leads to less price sensitivity in consumers. Choose a product that is available online and in stores (books or tires, for example) and ask the students to research the various pricings choices available online. After collecting this data, ask the students to comment on whether or not, the variety of price points found lowers their price sensitivity? For many firms pricing is the domain of the financial disciplines in the company. Using accepted accounting and financial processes, some companies’ price strictly according to these models. Assign students the assumed role of “defenders” of this practice and others as “innovators,” challenging these models and supporting some of the newer pricing models such as “perceived” and “value” pricing for products. Have the students come prepared to defend their positions using the concepts developed in this chapter. Paul W. Farris and David J. Reibstein, in their article, “How Prices, Expenditures, and Profits Are Linked,” Harvard Business Review (November–December, 1979), pp. 173– 184, found a relationship between relative price, relative quality, and relative advertising (their findings are summarized in the chapter). Students should read the full report, and then be prepared to discuss the validity of this study in light of the consumer information explosion that has occurred due to the emergence of the Internet. Are these relationships still valid today? If not, why or what has caused them to change? END-OF-CHAPTER SUPPORT MARKETING DEBATE—Is the Right Price a Fair Price? Prices are often set to satisfy demand or to reflect the premium that consumers are willing to pay for a product or service. Some critics shudder, however, at the thought of $2 bottles of water, $150 running shoes, and $500 concert tickets. Take a position: ‘Prices should reflect the value that consumers are willing to pay’ versus ‘Prices should primarily just reflect the cost involved in making a product or service’. Pro: Price, perhaps more than any other element of the marketing mix, communicates value to the consumer. In the consumer decision-making process, we have learned that customers are value-maximizers. They form an expectation of value and act on it. A buyer’s satisfaction is a function of the product’s perceived performance and the buyer’s expectations. So, if the product meets these consumers’ value definitions and the given price point reflects these values, price is seen as acceptable. If the price and the product’s value definition in the minds of the consumer are not consistent, sales will decline and prices will drop until prices reach equilibrium with the consumers’ definition of value. Con: Marketers have an obligation to the consumers to produce products (or services) that meet consumer needs at the lowest price possible. Fair pricing does not assign any consumer “value” definition into its equation and it should not because each consumer will have differing definitions of “value” according to their prejudices. When marketers try to “assign” a “value definition” to its product, it runs the risks of alienating current customers and missing other potential customers. Therefore, assigning a “fair” price, composed of actual costs plus fair margins, allows the marketer to maximize its customer bases. MARKETING DISCUSSION Think of the various pricing methods—markup pricing, target-return pricing, perceived-value pricing, value pricing, going-rate pricing, and auction-type pricing. As a consumer, which method do you personally prefer to deal with? Why? If the average price were to stay the same, which would you prefer: (1) for firms to set one price and not deviate or (2) to employ slightly higher prices most of the year, but slightly lower discounted prices or specials for certain occasions? Suggested Response: Student answers will differ. However, the following notation from research is worth reenforcing during the class discussions. The two different pricing strategies have been shown to affect consumer price judgments. Deep discounts (EDLP) can lead to lower perceived prices by consumers over time than frequent shallow discounts (high–low) even if the actual averages are the same. As a consumer, I prefer perceived-value pricing because it aligns the price with the value I perceive in the product, enhancing my satisfaction. Given a constant average price, I would prefer slightly higher prices with occasional discounts, as it offers flexibility and potential savings while still providing a sense of value through special offers. Marketing Lesson: EU YAN SANG What choices are available to Eu Yan Sang with regards to pricing decisions? Suggested Answer: Students’ answers will vary. The methods of markup pricing, targetreturn pricing and perceived-value pricing may all be used by Eu Yan Sang. Ensure students justify their answers by relating to information in the case study. Eu Yan Sang can choose between premium pricing to reflect its high-quality products and heritage, or competitive pricing to attract a broader customer base. They can also opt for value-based pricing by emphasizing health benefits and unique product attributes to justify higher prices. What impact will there be if Eu Yan Sang were to go ahead with increasing the prices of its products? Suggested Answer: As the industry leader, any price increase by Eu Yan Sang will trigger reactions by its closest competitors. Initially, some may hold or even lower their prices as they too have long-term bulk purchase contracts and have large inventories. This would enable them to promote their obviously more affordable prices. Eventually, the major competitors will increase prices as well to cover costs, leading to an overall increase in the prices of TCM products. Increasing prices at Eu Yan Sang could enhance perceived product quality and exclusivity but may risk losing price-sensitive customers and face resistance unless justified by added value or improved benefits in their offerings In your opinion, should Eu Yan Sang delay implementing a price increase? Why or why not? Suggested Answer: Ultimately it depends on their stock of TCM products and inventories. For products exclusive to Eu Yan Sang, price increases may be justifiable within the Government regulations. For substitutable products carried by competitors, there is the risk of customers being lost. Eu Yan Sang should consider delaying a price increase to assess market conditions and consumer sentiment, ensuring it aligns with perceived value and does not adversely affect customer loyalty or market share during uncertain economic periods. Marketing Lesson: EBAY Why has eBay succeeded as an online auction marketplace while so many others have failed? Yet, why has eBay failed in Asia while others such as Yahoo! and local sites have flourished? Suggested Answer: eBay’s success truly created a pricing revolution by allowing buyers to determine what they would pay for an item; the result pleases both sides because customers gain control and receive the best possible price while sellers make good margins due to the site’s efficiency and wide reach. For years, buyers and sellers used eBay as an informal guide to market value. eBay has evolved to also offer a fixed-price “buy it now” option to those who don’t want to wait for an auction and are willing to pay the seller’s price. eBay faces difficulties expanding globally into Asian markets such as China, Japan, and South Korea. In 2003, eBay acquired China’s first online auction site, EachNet, for $180 million. When Taobao, partially owned by Yahoo China via Alibaba, came along, it grew from strength to strength at the expense of eBay. Unlike eBay, Taobao does not charge its sellers a listing fee. Thus, when faced with a choice, Chinese entrepreneurs prefer the absence of fees. Another challenge for eBay in Asia is to convince the region that much of its usual buying and selling ought to be done online. eBay succeeded globally due to its early mover advantage, strong brand recognition, and robust platform; its failure in Asia stemmed from cultural differences, fierce local competition, and inability to adapt to regional preferences and payment methods effectively. Evaluate eBay’s fee structure. Is it optimal or could it be improved? Why? How? Suggested Answer: eBay’s pricing structure was developed to attract high-volume sellers and deter those who list only a few low-priced items. With eBay’s expansion into a wide range of other categories—from boats and cars and travel and tickets to health and beauty and home and garden—collectibles now make up only a small percentage of eBay sales and eBay can and should revisit its pricing structure to maximize profits on products that more and more people are buying—the fixed price option. eBay's fee structure could be seen as suboptimal due to high fees on final sale prices and listing costs, which may deter small sellers. Improvements could involve tiered fee structures based on seller volume or value, reducing initial listing fees, and clearer fee breakdowns to enhance seller satisfaction and competitiveness. What is next for eBay? How does it continue to grow when it needs both buyers and sellers? Where will this growth come from? Suggested Answer: Students answers will vary. Some might suggest that eBay will become or morph into a version of AMAZON.COM. Others think that eBay’s business plan and popularity will fade as other retailers embark on “auction” type selling—either English or Dutch auction. eBay's growth will likely hinge on expanding its user base globally, enhancing seller tools, and integrating advanced technologies like AI for personalized experiences, driving both buyer engagement and seller success. DETAILED CHAPTER OUTLINE Price is the one element of the marketing mix that produces revenue; the other elements produce costs. Prices are perhaps the easiest element of the marketing program to adjust; product features, channels, and even promotion take more time. Price also communicates to the market the company’s intended value positioning of its product or brand. A well-designed and marketed product can command a price premium and reap big profits. But new economic realities have caused many consumers to pinch pennies, and many companies have had to carefully review their pricing strategies as a result. Pricing decisions are clearly complex and difficult, and many marketers neglect their pricing strategies. Holistic marketers must take into account many factors in making pricing decisions—the company, customers, competition, and marketing environment. Pricing decisions must be consistent with the firm’s marketing strategy and its target markets and brand positionings. UNDERSTANDING PRICING Price is not just a number on a tag or an item. Price comes in many forms and performs many functions. Throughout most of history prices were set by negotiation between buyers and sellers. Bargaining is still prevalent in many parts of Asia today. Setting one price for all buyers is a relatively modern idea in the region. Traditionally, price has operated as the major determinant of buyer choice. A CHANGING PRICING ENVIRONMENT Pricing practices have changed significantly. The global recession resulted in many jobs lost. The renewed frugality has forced consumers to rethink how they spend their money. In Asia, some economies rebounded quickly. This has led some firms to buck the low-price trend and get consumers to trade up to more expensive products and services by combining unique product formulations with engaging marketing campaigns. Even products in fiercely competitive supermarket categories have been able to enjoy price hikes for the right new offerings. Also, the Internet has changed how buyers and sellers interact. Here is a list of how the Internet allows sellers to discriminate between buyers, and buyers to discriminate between sellers. Buyers can: Get instant price comparisons from thousands of vendors. Name their price and have it met. Get products free. Monitor customer behavior and tailor offers to individuals. Give certain customers access to special prices. Negotiate prices in online auctions and exchanges. Marketing Insight: Giving It All Away Giving away products free via sampling has been a successful marketing tactic for years; today with the advent of the Internet software, product and service companies are following suit. Ryanair is an example. HOW COMPANIES PRICE Companies do their pricing in a variety of ways. In small companies, prices are often set by the boss. Where pricing is a key factor, companies often establish a pricing department to set or assist others in setting appropriate prices. In large companies, division and product-line managers do. Even here, top management sets general pricing objectives and policies, and often approves the prices proposed by lower levels of management. Effectively designing and implementing pricing strategies requires a thorough understanding of consumer pricing psychology and a systematic approach to setting, adapting, and changing prices. CONSUMER PSYCHOLOGY AND PRICING Marketers recognize that consumers are not “price takers.” Purchase decisions are based on how consumers perceive prices. What they consider the current actual price—not the marketer’s stated price. Consumers may have a lower price threshold below which prices may signal inferior or unacceptable quality. Upper price threshold above which prices are prohibitive and seen as not worth the money. Understanding how consumers arrive at their perceptions of prices is an important marketing priority. Reference Prices When examining products, consumers often employ reference prices. In considering an observed price, consumers often compare it to an internal reference price (pricing from memory). An external frame of reference (posted “regular retail price”). All types of reference prices are possible (See Table 14.1). “Fair price” Typical price Last price paid Upper-Bound price Lower-Bound price Historical competitor price Expected future price Usual discounted price When consumers evoke one or more of these frames of reference, their perceived price can vary from the stated price. These “unpleasant surprises”—when perceived price is lower than the stated price—can have a greater impact on purchase. Consumer expectations also play a key role in price response. Price-Quality Inferences Many consumers use price as an indicator of quality. Some brands adopt scarcity as a means to signify quality and justify premium pricing. Price Endings Many sellers believe that prices should end in an odd number. Research has shown that consumers tend to process prices in a “left-to-right” manner rather than by rounding. Price encoding in this fashion is important if there is a mental price break at the higher, rounded price. Another explanation for “9” endings is that they convey the notion of a discount or bargain, suggesting that if a company wants a high-price image, it should avoid the odd-ending tactic. Prices that end with “0” and “5” are also common as they are thought to be easier for consumers to process and retrieve from memory. Pricing cues such as sale signs and prices that end in 9 become less effective the more they are employed. SETTING THE PRICE A firm must set a price for the first time when it develops a new product, when it introduces its regular product. The firm must decide where to position its product on quality and price. Most marketers have three to five price points or tiers. The firm has to consider many factors in setting its pricing policy. 1) Six-step procedure Selecting the pricing objective Determining demand Estimating costs iv. Analyzing competitors’ costs, prices, and offers Selecting a pricing method Selecting the final price STEP 1: SELECTING THE PRICING OBJECTIVE The company first decides where it wants to position its market offering. The clearer a firm’s objectives, the easier it is to set price. The five major objectives are: survival, maximum current profit, maximum market share, maximum market skimming, and product-quality leadership. Survival Companies pursue survival as their major objective when they are plagued with overcapacity, intense competition, or changing consumer wants. Survival is a short-run objective. Maximum Current Profit Many companies try to set a price that will maximize current profits. They estimate the demand and costs associated with alternative prices and choose the price that produces maximum current profit, cash flow, or rate of return on investment. Maximum Market Share Some companies want to maximize their market share. They believe that a higher sales volume will lead to lower unit costs and higher long-run profit. A) This practice is called market-penetration pricing. B) The following conditions favor setting a low price: The market is highly price-sensitive, and a low price stimulates market growth. Production and distribution costs fall with accumulated production experience. A low price discourages actual and potential competition. Maximum Market Skimming Companies unveiling a new technology favor setting high prices to maximize market skimming. This is also called market-skimming pricing, where prices start high and are slowly lowered over time. Product-Quality Leadership A company might aim to be the product-quality leader in the market. Many brands strive to be “affordable luxuries”—products or services characterized by high levels of perceived quality, taste, and status with a price just high enough not to be out of consumer’s reach. Other Objectives Nonprofit and public organizations may have other pricing objectives. A university aims for partial cost recovery, knowing that it must rely on private gifts and public grants to cover the remaining costs. A non-profit hospital may aim for full cost recovery in its pricing. A non-profit theater company may price its productions to fill the maximum number of theater seats. A social service agency may set a service price geared to client income. STEP 2: DETERMINING DEMAND Each price will lead to a different level of demand and therefore have a different impact on a company’s marketing objectives. The relation between alternative prices and the resulting current demand is captured in a demand curve (see Figure 14.1). Price Sensitivity The demand curve shows the market’s probable purchase quantity at alternative prices. The first step in estimating demand is to understand what affects price sensitivity. Generally, customers are less price-sensitive to low-cost items or items they buy infrequently. They are also less price sensitive when: There are few or no substitutes or competitors They do not readily notice the higher price They are slow to change their buying habits They think the higher prices are justified Price is only a small part of the total cost of obtaining, operating, and servicing the product over its lifetime A seller can charge a higher price than competitors and still get the business if the company can convince the customer that it offers the lowest total cost of ownership. Companies prefer customers who are less price-sensitive. Table 14.2 lists some characteristics that are associated with decreased price sensitivity. Asian consumers generally tend to be price sensitive and are pragmatic shoppers, particularly for private consumption goods. Three factors contribute to Asians’ price consciousness: Asia’s collectivistic orientation, which places greater value on personal relationships than on material goods, leads to greater pragmatism in buying products for private consumption. Asians have a habit of frugality, which stems from a lack of social welfare outside of the family, and encourages wealth accumulation within the family. Indeed, household savings in China, Taiwan, Japan, and Singapore are among the highest in the world. Asians have been known for their sophistication with money handling, especially in southern China and the mercantile overseas Chinese communities, leading to money, while not being hoarded, also not being wasted. Estimating Demand Curves Most companies attempt to measure their demand curves using several different methods. Surveys can explore how many units consumers would buy at different proposed prices. Price experiments can vary the prices of different products to see how the change affects sales. Statistical analysis of past prices, quantities sold, and other factors can reveal their relationships. These can be: Longitudinal Cross-sectional Price Elasticity of Demand Marketers need to know how responsive, or elastic, demand would be to a change in price. Consider the two demand curves in Figure 14.2. The higher the elasticity, the greater the volume growth resulting from a 1% price reduction. If demand is elastic, sellers will consider lowering the price. Price elasticity depends on the magnitude and direction of the contemplated price change. It may be negligible with a small price change and substantial with a large price change. It may differ for a price cut versus a price increase, and there may be a price indifference band within which price changes have little or no effect. Long-run price elasticity may differ from short-run elasticity. Buyers may continue to buy from a current supplier after a price increase but eventually switch suppliers. Here demand is more elastic in the long run than in the short run, or the reverse may happen: Buyers may drop a supplier after a price increase but return later. The distinction between short-run and long-run elasticity means that sellers will not know the total effect of a price change until time passes. STEP 3: ESTIMATING COSTS Demand sets a ceiling on the price the company can charge for its product. Costs set the floor. Types of Costs and Levels of Production A company’s costs take two forms, fixed and variable. Fixed costs (also known as overhead) are costs that do not vary with production or sales revenue. Variable costs vary directly with the level of production. Total costs consist of the sum of the fixed and variable costs for any given level of production. Average cost is the cost per unit at that level of production. Management wants to charge a price that will at least cover the total production costs at a given level of production. To price intelligently, management needs to know how its costs vary with different levels of production. To estimate the real profitability of dealing with different retailers, the manufacturer needs to use activity-based accounting (ABC). Accumulated Production The decline in the average cost with accumulated production experience is called the experience curve or learning curve. Experience-curve pricing carries major risks. Aggressive pricing might give the product a cheap image. The strategy assumes that competitors are weak followers. Most experience-curve pricing has focused on manufacturing costs, but all costs, including marketing costs, can be improved on. Target Costing Costs change with production scale and experience. They can also change as a result of a concentrated effort to reduce them through target costing. The objective is to bring the final cost projections into the target cost range. STEP 4: ANALYZING COMPETITORS’ COSTS, PRICES, AND OFFERS Within the range of possible prices determined by market demand and company costs, the firm must take competitors’ costs, prices, and possible price reactions into account. The firm should first consider the nearest competitor’s price. The introduction of any price or the change of any existing price can provoke a response from customers, competitors, distributors, suppliers, and even the government. How can a firm anticipate a competitor’s reactions? One way is to assume the competitor reacts in the standard way to a price being set or changed. Another is to assume the competitor treats each price difference or change as a fresh challenge and reacts according to self-interest at the time. STEP 5: SELECTING A PRICING METHOD Given the customers’ demand schedule, the cost function, and competitors’ prices, the company is now ready to select a price. Figure 14.5 summarizes the three major considerations in price setting. Costs set the floor to the price. Competitors’ prices and the price of substitutes provide an orienting point. Customers’ assessment of unique features establishes the price ceiling. There are six price-setting methods: Markup pricing Target-return pricing Perceived-value pricing Value pricing Going-rate pricing Auction-type pricing Markup Pricing The most elementary pricing method is to add a standard markup to the product’s cost. Does the use of standard markups make logical sense? Generally, no. Any pricing method that ignores current demand, perceived value, and competition is not likely to lead to the optimal price. Markup pricing remains popular. Sellers can determine costs much more easily than they can estimate demand. By tying the price to cost, sellers simplify the pricing task. Where all firms in the industry use this pricing method, prices tend to be similar. Many people feel that cost-plus pricing is fairer to both buyers and sellers. Target-Return Pricing In target-return pricing, the firm determines the price that would yield its target rate of Return On Investment (ROI). Target-return pricing tends to ignore price elasticity and competitors’ prices. Perceived-Value Pricing An increasing number of companies base their price on the customer’s perceived value. They must deliver the value promised by their value proposition, and the customer must perceive this value. A) Perceived value is made up of several characteristics: Buyer’s image of the product performance Channel deliverables The warranty quality 4) Customer support Supplier’s reputation Trustworthiness Esteem The key to perceived-value pricing is to deliver more value than the competitor and to demonstrate this to prospective buyers. Table 14.3 A Framework of Questions for Practicing Value-Based Pricing Value Pricing In recent years, several companies have adopted value pricing: they win loyal customers by charging a fairly low price for a high-quality offering. Value pricing is not a matter of simply setting lower prices. It involves reengineering the company’s operations to become a low-cost producer without sacrificing quality. Lowering prices significantly helps to attract a large number of value-conscious customers. An important type of value pricing is everyday low pricing (EDLP) that takes place at the retail level. A retailer who holds to an EDLP pricing policy charges a constant low price with little or no price promotions and special sales. In high-low pricing, the retailer charges higher prices on an everyday basis but then runs frequent promotions in which prices are temporarily lowered below the EDLP level. The two different pricing strategies have been shown to affect consumer price judgments. Deep discounts (EDLP) can lead to lower perceived prices by consumers over time than frequent shallow discounts (high-low) even if the actual averages are the same. Some retailers have even based their entire marketing strategy around what could be called extreme everyday low pricing. Going-Rate Pricing In going-rate pricing, the firm bases its price largely on competitor’s prices. The firm might charge the same, more, or less than major competitor(s). Going-rate pricing is quite popular where costs are difficult to measure or competitive response is uncertain. Auction-type pricing Auction-type pricing is growing more popular, especially with the growth of the Internet. There are three types of auction-type pricing: 1) English auctions (ascending bids) 2) Dutch auctions (descending bids) 3) Sealed-bid auctions STEP 6: SELECTING THE FINAL PRICE Pricing methods narrow the range from which the company must select its final price. In selecting the price, the company must consider additional factors, including the impact of other marketing activities, company pricing policies, gain-and-risk sharing pricing, and the impact of price on other parties. Impact of Other Marketing Activities The final price must take into account the brand’s quality and advertising relative to the competition. Paul Farris and David Reibstein examined the relationships among relative price, relative quality, and relative advertising for 227 consumer businesses, and found the following: Brands with average relative quality but high relative advertising budgets could charge premium prices. Consumers apparently were willing to pay higher prices for known products than for unknown products. Brands with high relative quality and high relative advertising obtained the highest prices. Conversely, brands with low quality and low advertising charged the lowest prices. The positive relationship between high prices and high advertising held most strongly in the later stages of the product life cycle for market leaders. Company Pricing Policies The price must be consistent with company pricing policies. Many companies set up a pricing department to develop policies and establish or approve pricing decisions. The aim is to ensure that salespeople quote prices that are reasonable to customers, and profitable to the company. Marketing Insight: Stealth Price Increases Companies trying to figure out how to increase revenue without really increasing prices are increasingly charging additional fees for what had once been free features/services. Gain-and-Risk Sharing Pricing Buyers may resist accepting a seller’s proposal because of a high-perceived level of risk. The seller has the option of offering to absorb part or all of the risk if he does not deliver the full promised value. Impact of Price on Other Parties Management must also consider the reactions of other parties to the contemplated price. How will distributors and dealers feel about it? If they do not make enough profit, they may not choose to bring the product to market. Will the sales force be willing to sell at that price? How will competitors react? Will suppliers raise their prices when they see the company’s price? Will the government intervene and prevent this price from being charged? ADAPTING THE PRICE Companies usually do not set a single price but rather develop a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, delivery frequency, guarantees, service contracts, and other factors. Geographical Pricing (Cash, Countertrade, Barter) In geographical pricing, the company decides how to price its products to different customers in different locations and countries. Another issue is how to get paid. This issue is critical when buyers lack sufficient hard currency to pay for their purchases. Many buyers want to offer other items in payment, a practice known as countertrade. Barter. The buyer and seller directly exchange goods, with no money and no third party involved. Compensation deal. The seller receives some percentage of the payment in cash and the rest in products. A British aircraft manufacturer sold planes to Brazil for 70% cash and the rest in coffee. Buyback arrangement. The seller sells a plant, equipment, or technology to another country and agrees to accept as partial payment products manufactured with the supplied equipment. A U.S. chemical company built a plant for an Indian company and accepted partial payment in cash and the remainder in chemicals manufactured at the plant. Offset. The seller receives full payment in cash but agrees to spend a substantial amount of the money in that country within a stated time period. PepsiCo sold its cola syrup to Russia for rubles and agreed to buy Russian vodka at a certain rate for sale in the United States. PRICE DISCOUNTS AND ALLOWANCES Most companies will adjust their list price and give discounts and allowances for early payment, volume purchases, and off-season buying (see Table 14.3). Companies must do this carefully or find their profits much lower than planned. Discount pricing has become the modus operandi of a surprising number of companies offering both products and services. Some product categories tend to self-destruct by always being on sale. Discounting can be a useful tool if the company can gain concessions in return. Sales management needs to monitor the proportion of customers who are receiving discounts. Higher levels of management should conduct a net price analysis to arrive at the “real price” of their offering. PROMOTIONAL PRICING Companies can use several pricing techniques to stimulate early purchase: Loss-leader pricing Special-event pricing Special customer pricing Cash rebates Low-interest financing Longer payment terms Warranties and service contracts Psychological discounting Promotional-pricing strategies are often a zero-sum game. DIFFERENTIATED PRICING Companies often adjust their basic price to accommodate differences in customers, products, locations, and so on. Price discrimination occurs when a company sells a product or service at two or more prices that do not reflect a proportional difference in costs. In first-degree price discrimination, the seller charges a separate price to each customer depending on the intensity of his or her demand. In second-degree price discrimination, the seller charges less to buyers who buy a larger volume. In third-degree price discrimination, the seller charges different amounts to different classes of buyers, as in the following cases: Customer-segment pricing Product-form pricing Image pricing Channel pricing Location pricing Time pricing The airline and hospitality industries use yield management systems and yield pricing, by which they offer discounted but limited early purchases, higher-priced late purchases, and the lowest rates on unsold inventory just before it expires. The phenomenon of offering different pricing schedules to different consumers is exploding. Research shows that constant price variations work best in situations where there is no bond between buyer and seller. The tactic most companies favor, however, is to use variable prices as a reward rather than a penalty. Some forms of price discrimination are illegal. Price discrimination is legal if the seller can prove that its costs are different when selling different volumes or different quantities of the same product to retailers. Predatory pricing—selling below cost with the intent of destroying competition—is unlawful. For price discrimination to work, certain conditions must exist: Segmentable Resellable Protectable Cost Goodwill Legal. INITIATING AND RESPONDING TO PRICE CHANGES Companies often face situations when they may need to cut or raise prices. INITIATING PRICE CUTS Several circumstances might lead a firm to cut prices: Excess plant capacity Companies may initiate a price cut in a drive to dominate the market through lower costs. Either the company starts with lower costs or initiates price cuts in hope of gaining market share and lower costs. A price-cutting strategy involves possible traps: Low-quality trap Fragile market-share trap Shallow-pockets trap Price-war trap INITIATING PRICE INCREASES A successful price increase can raise profits considerably. This situation is illustrated in Table 14.5. A major circumstance provoking price increases is cost inflation. Rising costs unmatched by productivity gains squeeze profit margins and lead companies to regular rounds of price increases. Companies often raise their prices by more than the cost increase in anticipation of further inflation or governmental price controls, in a practice called anticipatory pricing. Another factor leading to price increase is over-demand. The price can be increased in the following ways: Delayed quotation pricing Escalator clauses Unbundling Reduction of discounts In passing on price increases to consumers, the company must avoid looking like a price gouger. Customer memories are long, and they can turn against companies they perceive as price gougers. Several techniques help consumers avoid sticker shock and a hostile reaction when prices rise: Sense of fairness must surround any price increase. Customers must be given advance notice so that they can do forward buying or shop around. Sharp price increases need to be explained in understandable terms. Making low-visibility price moves first is also a good technique: Eliminating discounts Increasing minimum order sizes Curtailing production of low-margin products Contracts or bids for long-term projects should contain escalator clauses based on such factors as increases in recognized national price indexes. Given strong consumer resistance, marketers go to great lengths to find alternate approaches that avoid increasing prices when they otherwise would have done so. Here are a few popular ones. Shrinking the amount of product instead of raising the price. (Coca-Cola downsized its drink cans from 355 ml to 330 ml; Nestlé maintained its size but raised the price.) Substituting less-expensive materials or ingredients. (Many candy bar companies substituted synthetic chocolate for real chocolate to fight price increases in cocoa.) Reducing or removing product features. Removing or reducing product services, such as installation or free delivery. Using less-expensive packaging material or larger package sizes. Reducing the number of sizes and models offered. Creating new economy brands. (Supermarkets such as Cold Storage and Park ‘N Shop sell house brands that are cheaper than national brands.) Responding to Competitor’s Price Changes How should a firm respond to a price cut initiated by a competitor? In general, the best response varies with the situation. The company must consider the product’s stage in the life cycle, its importance in the company’s portfolio, the competitor’s intentions and resources, the market’s price and quality sensitivity, the behavior of costs with volume, and the company’s alternative opportunities. In markets characterized by high product homogeneity, the firm should search for ways to enhance its augmented product. If it cannot find any, it will have to meet the price reduction. If the competitor raises its price in a homogeneous product market, other firms might not match it unless the increase will benefit the industry as a whole. Then the leader will have to roll back the increase. In non-homogeneous product markets, a firm has more latitude. It needs to consider the following issues: (1) Why did the competitor change the price? Was it to steal the market, utilize excess capacity, meet changing cost conditions, or lead an industry-wide price change? (2) Does the competitor plan to make the price change temporary or permanent? (3) What will happen to the company’s market share and profits if it does not respond? Are other companies going to respond? (4) What are the competitor’s and other firms’ responses likely to be to each possible reaction? Brand leaders also face lower-priced store brands. Three possible responses to low-cost competition are: (1) further differentiate the product or service, (2) introduce a low-cost venture, or (3) reinvent as a low-cost player. The right strategy depends on the ability of the firm to generate more demand or cut costs. Instructor Manual for Marketing Management: A South Asian Perspective Philip Kotler, Kevin Lane Keller, Abraham Koshy, Mithileshwar Jha 9789810687977, 9780132102926