CHAPTER 19 Pricing Concepts This chapter begins with the learning outcome summaries, followed by a set of lesson plans for you to use to deliver the content in Chapter 19. • Lecture (for large sections) on page 4 • Company Clips (video) on page 5 • Group Work (for smaller sections) on page 6 Review and Assignments begin on page 8 • Review questions • Application questions • Application exercise • Ethics Exercise • Video assignment • Case assignment Great Ideas for Teaching Marketing from faculty around the country begin on page 18 LEARNING OUTCOMES 19-1 Discuss the importance of pricing decisions to the economy and to the individual firm Pricing plays an integral role in the U.S. economy by allocating goods and services among consumers, governments, and businesses. Pricing is essential in business because it creates revenue, which is the basis of all business activity. In setting prices, marketing managers strive to find a level high enough to produce a satisfactory profit. Profit drives growth, salary increases, and corporate investment. Price × Sales Unit = Revenue Revenue − Costs = Profit Profit drives growth, salary increases, and corporate investment 19-2 List and explain a variety of pricing objectives Establishing realistic and measurable pricing objectives is a critical part of any firm’s marketing strategy. Pricing objectives are commonly classified into three categories: profit oriented, sales oriented, and status quo. Profit-oriented pricing is based on profit maximization, a satisfactory level of profit, or a target return on investment (ROI). The goal of profit maximization is to generate as much revenue as possible in relation to cost. Often, a more practical approach than profit maximization is setting prices to produce profits that will satisfy management and stockholders. The most common profit-oriented strategy is pricing for a specific ROI relative to a firm’s assets. The second type of pricing objective is sales oriented, and it focuses on either maintaining a percentage share of the market or maximizing dollar or unit sales. The third type of pricing objective aims to maintain the status quo by matching competitors’ prices. 19-3 Explain the role of demand in price determination Demand is a key determinant of price. When establishing prices, a firm must first determine demand for its product. A typical demand schedule shows an inverse relationship between quantity demanded and price: when price is lowered, sales increase; when price is increased, the quantity demanded falls. For prestige products, however, there may be a direct relationship between demand and price: the quantity demanded will increase as price increases. Marketing managers must also consider demand elasticity when setting prices. Elasticity of demand is the degree to which the quantity demanded fluctuates with changes in price. If consumers are sensitive to changes in price, demand is elastic; if they are insensitive to price changes, demand is inelastic. Thus, an increase in price will result in lower sales for an elastic product and little or no loss in sales for an inelastic product. 19-4 Understand the concepts of dynamic pricing and yield management systems When competitive pressures are high, a company must know when it can raise prices to maximize its revenues. Dynamic pricing allows companies to adjust prices on the fly to meet demand. Yield management systems use complex mathematical software to fill unused capacity profitably. The software uses techniques such as discounting early purchases, limiting early sales at these discounted prices, and overbooking capacity. These systems are used in service and retail businesses and are substantially raising revenues. 19-5 Describe cost-oriented pricing strategies The other major determinant of price is cost. Marketers use several cost-oriented pricing strategies. To cover their own expenses and obtain a profit, wholesalers and retailers commonly use markup pricing: they tack an extra amount on to the manufacturer’s original price. Another pricing strategy determines how much a firm must sell to break even; this amount in turn is used as a reference point for adjusting price. 19-6 Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price The price of a product normally changes as it moves through the life cycle and as demand for the product and competitive conditions change. Management often sets a high price at the introductory stage, and the high price tends to attract competition. The competition usually drives prices down because individual competitors lower prices to gain market share. Adequate distribution for a new product can sometimes be obtained by offering a larger-than-usual profit margin to wholesalers and retailers. The Internet enables consumers to compare products and prices quickly and efficiently. Price is also used as a promotional tool to attract customers. Special low prices often attract new customers and entice existing customers to buy more. Large buyers can extract price concessions from vendors. Such demands can squeeze the profit margins of suppliers. Perceptions of quality can also influence pricing strategies. 19-7 Describe the procedure for setting the right price The process of setting the right price on a product involves four major steps: (1) establishing pricing goals; (2) estimating demand, costs, and profits; (3) choosing a price policy to help determine a base price; and (4) fine-tuning the base price with pricing tactics. A price strategy establishes a long-term pricing framework for a good or service. The three main types of price policies are price skimming, penetration pricing, and status quo pricing. 19-8 Identify the legal constraints on pricing decisions Government regulation helps monitor four major areas of pricing: unfair trade practices, price fixing, price discrimination, and predatory pricing. Many states have enacted unfair trade practice acts that protect small businesses from large firms that operate efficiently on extremely thin profit margins; the acts prohibit charging below-cost prices. The Sherman Act and the Federal Trade Commission Act prohibit both price fixing, which is an agreement between two or more firms on a particular price, and predatory pricing, in which a firm undercuts its competitors with extremely low prices to drive them out of business. Finally, the Robinson-Patman Act of 1936 makes it illegal for firms to discriminate between two or more buyers in terms of price. Predatory pricing is the practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. 19-9 Explain how discounts, geographic pricing, and other pricing tactics can be used to fine-tune a base price Several techniques enable marketing managers to adjust prices within a general range in response to changes in competition, government regulation, consumer demand, and promotional and positioning goals. Techniques for fine-tuning a price can be divided into three main categories: discounts, allowances, rebates, and value-based pricing; geographic pricing; and other pricing tactics. The first type of tactic gives lower prices to those who pay promptly, order a large quantity, or perform some function for the manufacturer. Additional tactics in this category include seasonal discounts, promotion allowances, and rebates (cash refunds). Geographic pricing tactics—such as FOB origin pricing, uniform delivered pricing, zone pricing, freight absorption pricing, and basing-point pricing—are ways of moderating the impact of shipping costs on distant customers. A variety of other pricing tactics stimulate demand for certain products, increase store patronage, and offer more merchandise at specific prices. More and more customers are paying price penalties, which are extra fees for violating the terms of a purchase contract. The perceived fairness or unfairness of a penalty may affect some consumers’ willingness to patronize a business in the future. TERMS bait pricing inelastic demand promotional allowance (trade allowance) base price key stoning quantity discount basing-point pricing leader pricing (loss-leader pricing) rebate break-even analysis market share return on investment (ROI) cash discount markup pricing revenue consumer penalty noncumulative quantity discount seasonal discount cumulative quantity discount odd-even pricing (psychological pricing) single-price tactic demand penetration pricing status quo pricing dynamic pricing predatory pricing supply elastic demand price two-part pricing elasticity of demand price bundling unfair trade practice acts extranet price fixing uniform delivered pricing fixed cost price lining value-based pricing flexible pricing (variable pricing) price skimming variable cost FOB origin pricing price strategy yield management systems (YMS) freight absorption pricing profit zone pricing functional discount (trade discount) LESSON PLAN FOR LECTURE Brief Outline and Suggested PowerPoint Slides: Learning Outcomes and Topics PowerPoint Slides LO1 Discuss the importance of pricing decisions to the economy and to the individual firm 19-1 The Importance of Price 1: Pricing Concepts 2: Learning Outcomes 3: Learning Outcomes 4: Learning Outcomes 5: The Importance of Price 6: The Importance of Price 7: What Is Price? 8: The Importance of Price to Marketing Managers LO2 List and explain a variety of pricing objectives 19-2 Pricing Objectives 9: Pricing Objectives 10: Pricing Objectives 11: Profit-Oriented Pricing Objectives 12: Profit Maximization 13: Return on Investment (ROI) 14: Sales-Oriented Pricing Objectives 15: Market Share 16: Sales Maximization 17: Status Quo Pricing Objectives LO3 Explain the role of demand in price determination 19-3 The Demand Determinant of Price 18: The Demand Determinant of Price 19: The Demand Determinant of Price 20: How Demand and Supply Establish Price 21: Elasticity of Demand 22: Factors that Affect Elasticity of Demand LO4 Understand the concepts of dynamic pricing and yield management systems 19-4 The Power of Dynamic Pricing and Yield Management Systems 23: The Power of Dynamic Pricing and Yield Management Systems 24: Dynamic Pricing 25: Yield Management Systems 26: Yield Management Systems LO5 Describe cost-oriented pricing strategies 19-5 The Cost Determinant of Price 27: The Cost Determinant of Price 28: The Cost Determinant of Price 29: Setting Prices 30: Markup Pricing LO6 Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet and extranets, and perceptions of quality can affect price 19-6 Other Determinants of Price 31: Other Determinants of Price 32: Other Determinants of Price 33: Stages in the Product Life Cycle 34: The Competition 35: Distribution Strategy 36: The Impact of the Internet and Extranets 37: Promotion Strategy 38: Demands of Large Customers 39: The Relationship of Price to Quality 40: Dimensions of Quality LO7 Describe the procedure for setting the right price 19-7 How to Set a Price on a Product 41: How to Set a Price on a Product 42: Setting the Right Price 43: Choose a Price Strategy 44: Price Skimming 45: Penetration Pricing 46: Status Quo Pricing LO8 Identify the legal constraints on pricing decisions 19-8 The Legality of Price Strategy 47: The Legality of Price Strategy 48: The Legality of Price Strategy 49: Unfair Trade Practices and Price Fixing 50: Price Discrimination 51: Price Discrimination 52: Predatory Pricing LO 9 Explain how discounts, geographic pricing, and other pricing tactics can be used to fine-tune a base price 19-9 Tactics for Fine-Tuning the Base Price 53: Tactics for Fine-Tuning the Bae Price 54: Tactics for Fine-Tuning the Bae Price 55: Discounts, Allowances, Rebates, and Value-Based Pricing 56: Geographic Pricing 57: Other Pricing Tactics 58: Consumer Penalties 59: Chapter 19 Video 60: Part 6 Video Suggested Homework: • The end of this chapter contains assignments on the Ski Butternut video. • This chapter’s online study tools include flashcards, visual summaries, practice quizzes, and other resources that can be assigned or used as the basis for longer investigations into marketing. LESSON PLAN FOR VIDEO Company Clips Segment Summary: Ski Butternut Ski Butternut is a ski mountain in the Berkshires dedicated to offering a great family ski value. In this video, Matt Sawyer discusses the various ways that Ski Butternut uses pricing to drive new business and local business to the mountain. He also discusses how correct pricing can help the next year’s business model through season pass sales. These teaching notes combine activities that you can assign students to prepare before class, that you can do in class before watching the video, that you can do in class while watching the video, and that you can assign students to complete as assignments after watching the video in class. During the viewing portion of the teaching notes, stop the video periodically where appropriate to ask students the questions or perform the activities listed on the grid. You may even want to give the students the questions before starting the video and have them think about the answer while viewing the segment. That way, students will be engaged in active rather than passive viewing. PRE-CLASS PREP FOR YOU: PRE-CLASS PREP FOR YOUR STUDENTS: • Preview the Company Clips video segment for Chapter 19. This exercise reviews concepts for LO1–LO6. • Review your lesson plan. • Make sure you have all of the equipment needed to show the video to the class, including the DVD and a way to project the video. • You can also stream the video HERE • Have students review and familiarize themselves with the following terms and concepts: importance of pricing decisions, pricing objectives, demand determinant of price, and cost determinant of price. • Have students bring written definitions of the above terms or concepts to class. • Ask students to visit http://www.skibutternut.com/ and review its current pricing. VIDEO REVIEW EXERCISE ACTIVITY Warm Up Briefly discuss students’ findings from the Pre-Class Prep activity about the Ski Butternut Web site. Was pricing straightforward and easy to understand? Who is the target market? In-class Preview • Discuss pricing objectives with the class. Highlight the concepts of profit maximization, target ROI, and sales maximization. • Discuss demand determinants of price with the class. Point out how demand and supply work together to determine price, the elasticity of demand, and how yield management systems work. • Have copies of the Company Clips questions (below) available for students to take notes on while viewing the video segment. Viewing (solutions below) 1. How do the product, place, and promotion elements of Ski Butternut’s marketing mix influence the pricing strategy the company has chosen? 2. Would you expect demand for Ski Butternut lift tickets to be elastic? Why or why not? 3. What role do the product life cycle, competition, and perceptions of quality play in Ski Butternut’s pricing? Follow-up • Divide students into groups of three to five and have them figure out a way to apply a yield management system (YMS) to Ski Butternut’s business model. Give them about 5 to 10 minutes to come up with a solution, and, time permitting, have them share their ideas with the class. • What type of pricing strategy does Ski Butternut employ? Solutions for Viewing Activities 1. How do the product, place, and promotion elements of Ski Butternut’s marketing mix influence the pricing strategy the company has chosen? Answer: Ski Butternut offers rentals, lift tickets, and classes on its beginner-level mountain, which is located relatively near towns in Massachusetts (compared to other mountains in the Berkshires). These features enable Ski Butternut to price towards families and to offer great package rates compared to other mountains. 2. Would you expect demand for Ski Butternut lift tickets to be elastic? Why or why not? Answer: Matt reveals that demand for Ski Butternut is elastic when he discusses holiday rates being higher in order to ensure good ski quality, which means lower prices increases demand. 3. What role do the product life cycle, competition, and perceptions of quality play in Ski Butternut’s pricing? Answer: PLC plays less of a role in Butternut’s pricing. Skiing is a very mature industry, but it is challenging for new competitors to open new mountains. Existing competition is much more of a concern for Ski Butternut, which has addressed the simplicity of its mountain by adding terrain parks, which attract a younger audience. Ski Butternut wants to be a family mountain that offers quality skiing for the target market, but its pricing reflects that it is for families and to encourage college students to Ski Butternut. LESSON PLAN FOR GROUP WORK Class Activity 1 – Retail Price Comparison To demonstrate to students the wide variation in pricing of an identical item, ask them to visit three different stores and compare prices on similar items. First, each student should select a category of store. Some suggestions are: • Grocery: large chain store, local chain store, convenience store • Health and beauty aids: grocery store, drugstore, discount store • Over-the-counter drugs: chain drugstore, local drugstore, discount store • Clothing: specialty store, department store, discount store A student who chooses to investigate clothing stores could compare the price of Levi's 501 jeans for men at the three different types of stores. A student who chooses health and beauty aids could compare the price of a certain brand of shampoo (same size, weight, and so on) at the three stores. Students may come up with other categories and items of interest. If possible, each student should select several items to compare in his or her category. For example, in the grocery category, a student may want to compare a type of cereal, a canned soup, and a snack item. Students who travel home every weekend may want to compare prices between towns, which is also a very interesting exercise. After the investigation, ask students what factors they believe lead to the variations in prices. Is it worthwhile for consumers to compare prices when they shop? This assignment can lead to a very interesting discussion of price competition, nonprice competition, odd even pricing, promotional pricing, price lining, and unit pricing. Class Activity 2 – Pricing Strategies The goal of this exercise is to make students aware of pricing strategies used by the airline industry. • Have your students collect price quotes for airline tickets to a city with departure dates that are less than 7, 14, and over 21 days from the present date. How do the prices differ? • Then have them include a Saturday night stay and no Saturday night stay. How do the prices vary now? • Have them check the same flight schedule comparing coach, business, and first class fares. • What kind of pricing strategy is being used? REVIEW AND ASSIGNMENTS FOR CHAPTER 19 REVIEW QUESTIONS 1. Why is pricing so important to the marketing manager? Answer: Revenue is what pays for every activity of the firm as well as producing profit. Price is a major determinant of revenue. 2. How does price allocate goods and services? Answer: Price sets the image of the good. In conjunction with quality, price is part of the formula for value. Even though price is part of the determination of value, the two factors do not necessarily have an inverse relationship. That is, when value is perceived as high, the price paid is not necessarily low. In other words, a good or service can have a high price and still be considered a good value. For example, some people buy expensive German cars not for the image, but because the cars have a higher residual value than most other cars. This means that even though the purchase price is high, the cost of ownership is low (better value). But if a company prices a product too high, consumers might be more inclined to buy a used version of the product instead of a new version. 3. Why do many firms not maximize profits? Answer: One reason that firms do not maximize value is that they can only charge a price that equates to a perceived value. As mentioned in solution 2, when customers do not perceive a value, they will not pay a higher price. Secondly, many firms lack the accounting data they need to track profit maximization. Accounting systems that can determine the actual point of profit maximization are extremely difficult to set up. 4. Explain the role of supply and demand in determining price. Answer: The price that is set depends on pricing goals and the demand for the good or service, the cost to the seller for that good or service, and other factors. Demand is the quantity of a product that will be sold in the market at various prices for a specified period. Ordinarily, the quantity demanded increases as the price decreases and decreases as the price increases. Supply is the quantity of product that will be offered to the market by suppliers at various prices for a specified period. Supply will increase as price increases. Competitive market prices are determined by a combination of supply and demand. Ineffective pricing can cause seller surplus or consumer shortage. 5. Explain the concepts of elastic and inelastic demand. Why should managers understand these concepts? Answer: Elasticity of demand refers to consumers' responsiveness or sensitivity to changes in price. Elastic demand occurs when consumers are sensitive to price changes, whereas inelastic demand means that an increase or decrease in price will not significantly affect demand for a product. A marketing manager needs to know whether a product has elastic or inelastic demand to estimate the effect of a price change on sales. 6. Explain the relationship between supply and demand and yield management systems. Answer: Supply and demand are fundamental economic concepts that directly influence pricing and availability of products or services. Yield management systems leverage this relationship by analyzing data on supply (inventory) and demand (customer booking patterns) to optimize pricing and maximize revenue. In essence, when demand is high and supply is low, yield management systems can increase prices to capture more revenue. Conversely, if supply exceeds demand, these systems might lower prices or offer discounts to stimulate bookings. By continuously adjusting prices based on real-time data, yield management helps businesses, particularly in industries like hospitality and airlines, maximize their profitability while meeting customer needs. 7. Why are so many companies adopting yield management systems? Answer: A yield management system (YMS) is a technique for adjusting prices so that unused capacity is filled. YMSs are very popular with industries that have high fixed costs, such as the airline industry or the hospitality (hotel) industry. As the need for a variety of services grow, the need for YMSs will also grow. YMSs allow firms to cut prices during times of low usage to fill capacity and absorb high fixed costs. 8. Why is it important for managers to understand the concept of break-even points? Are there any drawbacks? Answer: The advantage of break-even analysis is that a firm can quickly discover how much it must sell to cover costs and how much profit can be earned if higher sales volume is obtained. It is a simple formula requiring only cost information. The disadvantages of break-even analysis include the fact that it ignores demand and that some costs are difficult to categorize as fixed or variable. 9. Give an example of each major type of pricing objective. Answer: Pricing objectives are commonly classified into three categories and students are to come up with one example of each: • Profit-oriented pricing aims for profit maximization, satisfactory level of profit, or target return on investment. • Sales-oriented pricing aims to attain or maintain a certain market share or to maximize dollar or unit sales. • Status quo pricing aims to match competitors’ prices. 10. What are the three basic defenses that a seller can use if accused under the Robinson-Patman Act? Answer: The Robinson-Patman Act provides three defenses for the seller charged with price discrimination (in each case the burden is on the defendant to prove the defense): 1) cost—if the prices represent manufacturing or quantity discount savings, 2) market conditions—if the price variations are designed to meet fluid product or market conditions, or 3) competition—if the price is reduced to stay even with the competition. APPLICATION QUESTIONS 1. If a firm can increase its total revenue by raising its price, shouldn't it? Answer: It may only increase revenue in the short run. In the long run, buyers may find substitutes for the good, or competitors will be attracted to the market by the high prices and margin of profit to be made. In some cases, such as the price of prescription drugs, it might be construed to be unethical to raise prices to the upper limit. 2. Your firm has based its pricing strictly on cost in the past. As the newly hired marketing manager, you believe this policy should change. Write the president a memo explaining your reasons. Answer: Although students’ answers will vary, they should address some of these points: Prices determined strictly on the basis of costs may be too high for the target market, thereby reducing or eliminating sales. Cost-based pricing ignores demand. Also, if the price is too low, firms may unnecessarily sacrifice additional revenue. We need to look at the prices of similar or substitutable products in the marketplace. We should also research customer expectations, perceptions, and satisfaction with the pricing. 3. Divide the class into teams of five. Each team will be assigned a different grocery store from a different chain (an independent store is fine, too). Appoint a group leader. The group leaders should meet as a group and pick fifteen nationally branded grocery items. Each item should be specifically described as to brand name and size of the package. Each team will then proceed to its assigned store and collect price data on the fifteen items. The team should also gather price data on fifteen similar store brands and fifteen generics, if possible. Each team should present its results to the class and discuss why there are price variations between stores, national brands, store brands, and generics. As a next step, go back to your assigned store and share the overall results with the store manager. Bring back the manager’s comments and share them with the class. Answer: Results will vary by group. 1. Divide Class: Split into teams of five; assign each a different grocery store chain. 2. Group Leaders: Appoint a leader for each team; leaders meet to select 15 nationally branded grocery items (specifics: brand name and package size). 3. Data Collection: Teams visit their assigned stores to gather price data on: • 15 national brands • 15 store brands • 15 generic brands (if available). 4. Presentation: Teams present findings, discussing reasons for price variations between: • Stores • National brands vs. store brands vs. generics. 5. Manager Feedback: Teams return to their stores to share overall results with the store manager and gather their comments. 6. Class Sharing: Present the manager’s insights to the class for further discussion. 4. How does the stage of a product’s life cycle affect price? Give some examples. Answer: Demand factors and competitive conditions tend to change as a product moves through the different stages of its life cycle. In the introduction stage, prices are typically set high because of the need to recover development costs and because demand originates in the core of the market. However, if a market is highly price sensitive, a firm may introduce its product at a price lower than the competition’s to gain an advantage. In the growth stage, prices tend to decrease as competition increases, the market widens, and economies of scale are achieved. Price continues to decline in the maturity phase, because competition tends to squeeze out less efficient, higher-cost firms. Prices further decrease in the decline stage as the remaining companies attempt to appeal to dwindling sources of demand. Finally, if a product moves into the specialty category, prices may again rise because of an absence of competition. 5. Go to Priceline.com. Can you research a ticket’s price before purchasing it? What products and services are available for purchase? How comfortable are you with naming your own price? Relate the supply and demand curves to customer-determined pricing. Answer: Student answers will vary as to their comfort with naming their own price. Periodically, Priceline.com changes the product mix that is available. You should check the Web site at the time of the assignment. The final part of their answer should relate to the willingness of producers to lower their prices if the supply is greater than the demand. 6. You are contemplating a price change for an established product sold by your firm. Write a memo analyzing the factors you need to consider in your decision. Answer: Although students’ answers will vary, they should address some of these points: Before instituting a price change, managers should estimate demand, costs, and profits at several price levels to determine the combined impact on the firm. The firm also needs to consider the prices of the competition, the quality image of the product, the stage of life cycle of the product, available substitutes for the product, and the impact of the price on distribution and promotion strategies. 7. Develop a price line strategy for each of these firms: a) a college bookstore, b) a restaurant, c) a video-rental firm. Answer: Product line pricing is setting prices for an entire line of products, which is a broader concern than setting the right price on a single item. The college bookstore textbooks have a neutral relationship—demand is driven by the classes taken and books assigned. In a restaurant, there is a relationship between the different courses and in some instances, less expensive appetizers and drinks might be viewed as complementary. In other examples, the students might find the appetizers and desserts are substitutes. In the video store, a price line of the first-run movies at the highest price, and older movies and children’s movies at lower prices, would be a complementary strategy. 8. The U.S. Postal Service regularly raises the price of a first-class stamp but continues to operate in the red year after year. Is uniform delivered pricing the best choice for first-class mail? Answer: Students’ responses will vary. In general, it would seem more lucrative for the USPS to use zone pricing, but the logistical costs (and hassles) of doing so would probably offset any gains made increasing prices for farther destinations. This is a good question to use as the basis for a debate or small-group discussions in the class. APPLICATION EXERCISE Reliance on price as a predictor of quality seems to occur for all products. Does this mean that high-priced products are superior? Well, sometimes. Price can be a good predictor of quality for some products, but for others, price is not always the best way to determine the quality of a product or service before buying it. This exercise (and worksheet) will help you examine the price–quality relationship for a simple product: canned goods. Activities 1. Take a trip to a local supermarket where you are certain to find multiple brands of canned fruits and vegetables. Pick a single type of vegetable or fruit you like, such as cream corn or peach halves, and list five or six brands in the worksheet on the following page. Price 1 2 3 4 5 6 7 Brand Quality Rank (y) Price/Weight Price per Ounce Price Rank (x) d (y-x) d2 TOTAL 2. Before going any further, rank the brands according to which you think is the highest quality (1) to the lowest quality (5 or 6, depending on how many brands you find). This ranking will be y. 3. Record the price and the volume of each brand. For example, if a 14-ounce can costs $.89, you would list $.89/14 oz. 4. Translate the price per volume into price per ounce. Our 14-ounce can costs $.064 per ounce. 5. Now rank the price per ounce (we’ll call it x) from the highest (1) to the lowest (5 or 6, again depending on how many brands you have). 6. We’ll now begin calculating the coefficient of correlation between the price and quality rankings. The first step is to subtract x from y. Enter the result, d, in column 6. 7. Now calculate d2 and enter the value in column 7. Write the sum of all the entries in column 7 in the final row. 8. The formula for calculating a price–quality coefficient r is as follows: rs=1 – 6∑ d2 ( n3 – n) In the formula, rs is the coefficient of correlation, 6 is a constant, and n is the number of items ranked. 9. What does the result of your calculation tell you about the correlation between the price and the quality of the canned vegetable or fruit you selected? Now that you know this, will it change your buying habits? Purpose: To have students investigate the relationship between price and quality and perceptions of quality. Setting It Up: This exercise requires high-school algebra to calculate the price–quality coefficient. You can assign this as an individual or group project. This exercise was inspired by the following Great Idea in Teaching Marketing: Vaughn C. Judd Auburn University Montgomery ANALYZING THE PRICE–QUALITY RELATIONSHIP The relationship between product price and quality is more relevant to students when they analyze it using third-party data. Food product ratings in Cook’s Illustrated magazine provide the data for the analyses. Consumer Reports, however, can be used as a data source if Cook’s Illustrated is not readily available. The Spearman rank correlation coefficient, an easy statistic to calculate in class with a hand-held calculator, is used to measure the relationship. An Example of the Process Step 1: Students are grouped in teams of two or three. Each team is given a reprint of a different food review from Cook’s Illustrated magazine and a worksheet that is equivalent in form to Table 1, but with only the column headings. Step 2: The example, Table 1, is based on ratings of six brands of canned red kidney beans. Students list the brands in column 1 and the rank order of quality in column 2—the best quality being ranked number one. Although there are no ties in quality ranks in this example, brands are sometimes tied. Step 3: Students then list the price and volume of each brand in column 3. Since the cans contain different volumes, the prices from column 3 are converted to per ounce equivalents in column 4. The prices shown in column 4 are ranked from highest to lowest (1 = highest) in column 5. Note that there are two brands with identical prices—at $.030/ounce. Using the midrank method for handling ties, these brands are each ranked 5.5. Step 4: Students next calculate the coefficient of correlation between the quality and price rankings. First, they complete the d (difference) column by subtracting the x rank from the y rank for each brand, then the d2 column by squaring the values in the d column and summing them up. Finally, the coefficient of correlation is calculated. Step 5: Each group is asked to draw conclusions regarding the relationship between price and quality for the brands analyzed, and to report the conclusions to the class. The conclusions, based on the coefficients, are noted on the chalkboard. Also they are asked how successful a consumer would be in obtaining quality by picking the highest- or lowest-priced brands. With regard to canned red kidney beans, there is a strong association between quality and price. Unfortunately for consumers, the relationship is in the wrong direction as expressed by the –.90 coefficient. Also, out of the six brands evaluated, the highest-priced brand ranked last in quality. Table 1 Canned Red Kidney Beans (1) Brand (2) Quality Rank Price (6) d (y–x) (7) d2 (3) Price/Wt. (4) *Price per U (5) Price Rank Green Giant 1 $.59/15.5 oz. $.038 5.5 –4.5 20.25 Goya 2 $.59/15.5oz. $.038 5.5 –3.5 12.25 S&W 3 $1.09/15 oz. $.073 3 0 0 Progresso 4 $.89/19 oz. $.047 4 0 0 Wesbrae 5 $1.59/15 oz. $.106 2 3.0 9.00 Eden 6 $1.99/15oz. $.133 1 5.0 25.0 TOTAL 66.5 Source: Cook’s Illustrated (September/October 1997) *Converted to a per/ounce basis The formula for calculating Spearman’s rho is: rs = 1 – 6d2 (n3 – n) Where: rs= Spearman rank order correlation, d, = difference in rank in the paired rankings, n = number of items ranked, and 6 = a constant in the formula. Calculation: rs = 1 – 6(66.5)/(63 - 6) rs = l – (1.90) rs = –.90 Conclusion Discovering on one’s own is an important element of learning. This exercise provides that opportunity. Students sharing their discoveries with their fellow classmates further complement the learning process. Finally, from the shared findings there is an opportunity to generalize about the price–quality relationship. Obviously the results will vary depending on the product categories assigned. With regard to food products, however, experience has shown that there tends to be low levels of correlation between price and quality. ETHICS EXERCISE Advanced Bio Medics (ABM) has invented a new stem-cell–based drug that will arrest even advanced forms of lung cancer. Development costs were actually quite low because the drug was an accidental discovery by scientists working on a different project. To stop the disease requires a regimen of one pill per week for 20 weeks. There is no substitute offered by competitors. ABM is thinking that it could maximize its profits by charging $10,000 per pill. Of course, many people will die because they can’t afford the medicine at this price. 1. Should ABM maximize its profits? Answer: Profit maximization entails setting prices so that total revenue is as large as possible relative to total costs. It is not unethical on the face, but since ABM is in a monopoly position (i.e., there are no competitors or substitute products in this market), it risks charges of price gouging if its price of $10,000 per pill turns out to be exorbitant compared to the average total cost to make the pill. If the survival of the business is not dependent on the $10,000 per pill price, then it would be socially responsible to offer the pill at a lower price, or to use other pricing tactics to fine tune the $10,000 base price in certain markets. 2. Does the AMA Statement of Ethics address this issue? Go to http://www.marketingpower.com and review the Statement. Then write a brief paragraph on what the AMA Statement of Ethics contains that relates to ABM’s dilemma. Answer: The AMA Statement of Ethics does not specifically address profit maximization in its pricing section. The Statement does prohibit marketers from engaging in predatory pricing, but not in price gouging. Fortunately, the market has a way of taking care of price gouging on its own, either through increased competition, or through negative public relations that affect the gouging company’s stock price and market capitalization. VIDEO ASSIGNMENT: Ski Butternut Ski Butternut is a ski mountain in the Berkshires dedicated to offering a great family ski value. In this video, Matt Sawyer discusses the various ways that Ski Butternut uses pricing to drive new business and local business to the mountain. He also discusses how correct pricing can help the next year’s business model through season pass sales. 1. First time skiiers demonstrate elastic demand. A. True B. False Answer: A Because demand increased based on the lowered pricing of the package ($75 for a lift ticket, rental, and lesson), first time skiers have elastic demand. 2. When Ski Butternut reduced the first time skier package from $135 to $75, first time skiiers A. experienced unitary elasticity for ski lessons. B. saw a profit maximization scheme based on discounting the first visit and charging a lot more once the skier is hooked. C. saw a perceived reasonable value for an activity they haven’t tried yet. D. bartered for lower priced rentals. Answer: C Lowering the package price for first time skiers manages their expectations by offering a “reasonable price” for an activity they aren’t sure they will like, but are willing to try for the lower $75 dollars. 3. Knowing that weather can affect the profits for a ski area, but also that offering low prices drives more locals to Ski Butternut, Matt Sawyer is saying that Ski Butternut is aiming for profit maximization. A. True B. False Answer: B Ski Butternut is likely aiming for satisfactory profits that meet their operating costs and derive at least a small profit. This leaves room for weather related costs (such as little or no snow, which drives down ski demand) that can eat into profits. 4. Moving from $199 season pass to $275 season pass was part of a trial and error of pricing promotions for Ski Butternut. They have stayed at the $275 price point A. because it maximizes profits. B. because it meets costs without exceeding the competition’s prices. C. because it makes the cost an inconsequential part of an individual’s budget. D. because the decline stage can cause some prices to increase. Answer: B The $199 price was too low to meet costs, but the five-visit break-even pricing structure was low enough to draw customers away from more expensive mountains, but high enough to meet operating costs. 5. According to the video, college students respond really well when Ski Butternut takes $20 off the price of a lift ticket. College students A. are sensitive to price changes—they have inelastic demand. B. are sensitive to price changes—they have elastic demand. C. are sensitive to price changes—they have unitary elasticity. D. are insensitive to price changes—they have elastic demand. Answer: B Being sensitive to price changes, such as increasing demand for lift tickets at Ski Butternut when the price goes down $20, is having elastic demand. 6. Pricing lift tickets at $25 Monday-Friday to drive customers to Ski Butternut is an aggressive pricing structure designed to increase market share by taking mid-week skiers away from other mountains. A. True B. False Answer: A Matt Sawyer says that “everyone is trying to get people to come out mid-week, so we took an aggressive pricing structure” which implies that they are striving to take mid-week market share from other Berkshire mountains. 7. Matt Sawyer says that Ski Butternut increases its holiday prices by five dollars because otherwise the “quality of the experience will deteriorate.” This suggests that on holidays: A. supply exceeds demand B. the equilibrium price has been reached C. demand exceeds supply D. there is unitary elasticity Answer: C On Holidays, demand is high enough that there would be too many people on the slopes and the supply of space would be too low. So Ski Butternut raised the price to drive some demand to other days and be able to supply enough space on the slopes on holidays. CASE ASSIGNMENT: Price Matching In an effort to stem their losses and gain an advantage over their Internet competitors, Target and Best Buy recently announced a price-matching policy. During the holiday shopping season of 2012, both retailers promised that they would match the prices offered by a number of popular online retailers such as Amazon and Walmart.com. According to Target CEO Gregg Steinhafel, the price match move was intended to show consumers that Target should be their preferred shopping destination. “We’re already rock solid in price. But if periodically some competitor has a lower price, this gives our guests the ability to know ‘I can do all of my one-stop shopping in Target.’” On the surface of things, the price-match policies seem to favor consumers, since they can physically check out a product and get the lowest price. However, a number of exceptions to both policies made them difficult and frustrating to use. For example, shoppers have to ask for the price cuts and show proof of the lower price to an in-store employee. “Can you imagine,” asked CEO of CFI Group Sheri Petras, “being on the checkout line at Target with 21 items and you're scanning products on your phone to find out the gum is 12 cents less at Amazon? Can you imagine standing behind that person in line?” Many retail experts believe that, far from increasing physical store sales, such price-matching policies may actually do the opposite. They suggest that it is simply too difficult to match Internet prices since they fluctuate so much. Moreover, they argue that even with a price-match, there simply is not enough motivation for customers to drive to the store, wait in line, and hope that an employee doesn’t make them the exception to the rule. Ann Zimmerman, “We Promise to Match Prices*,” Wall Street Journal, October 18, 2012, B1, B4; Ann Zimmerman and Elizabeth Holmes, “Target Vows Price Match,” Wall Street Journal, October 17, 2012, B6; Tom Gara, “Best Buy’s Online Price Matching: There Is a Catch,” Wall Street Journal, October 12, 2012, http://blogs.wsj.com/corporate-intelligence/2012/10/12/best-buys-online-price-matching-there-is-a-catch (Accessed March 26, 2013). TRUE/FALSE 1. If, instead of case-by-case price matching, Target used Amazon’s pricing structure to set its own prices across the board, it would be using status quo pricing. Answer: True 2. If Amazon sells a product below cost, a Best Buy store located in a state with an unfair trade practice act could match Amazon’s price on that product. Answer: False Unfair trade practice acts put a floor under wholesale and retail prices in more than half of the United States. Selling below cost in these states is illegal. 3. Price matching is a form of flexible pricing. Answer: True 4. If it brings customers into the store instead of shopping online, there’s no such thing as pricing products too low. Answer: False Pricing products too low can reduce company profits. 5. If customers find Best Buy’s price matching policy too tedious or confusing, the retailer could still endeavor to keep prices low by paring down suppliers or keeping the pressure on existing ones. Answer: True MULTIPLE CHOICE 1. Which of the following statements suggests that Target uses penetration pricing? A. Target charges as high a price as possible for new video games and consumer electronics because there is high customer demand. B. Target matches Walmart’s prices on groceries and common household products. C. Target charges a relatively low price for its athletic clothing so it can capture a large share of the market. D. Target positions a $300 coffee maker next to a $75 one to make the latter model look cheap by comparison. Target positions a $300 coffee maker next to a $75 one to make the latter model look cheap by comparison. E. Target sells a wide variety of framed posters, but charges the same price for all of them. Answer: C Penetration pricing means charging a relatively low price for a product as a way to reach the mass market. 2. Suppose administrators of Amazon’s grocery section realize that a small town buys its milk from a small mom and pop grocery store for three dollars a gallon. Amazon advertises a sale in the town, offering milk for one dollar a gallon with free delivery. After the mom and pop shop goes out of business, Amazon raises its price of milk to four dollars a gallon. What illegal practice does this example illustrate? A. Unfair pricing. B. Price discrimination. C. Predatory pricing. D. Price fixing. E. None of these. Answer: C Predatory pricing is the practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. Once competitors have been driven out, the firm raises its prices. 3. Suppose that Best Buy’s price matching program proved unsuccessful. To encourage customer loyalty during the frenetic holiday period, Best Buy instituted a new policy whereby customers would receive two percent off all their purchases (up to 50 percent off) for every item they bought between November 25 and December 25. This exemplifies a: A. Cash discount. B. Seasonal discount. C. Functional discount. D. Cumulative quantity discount. E. Noncumulative quantity discount. Answer: D A cumulative quantity discount is a deduction from list price that applies to the buyer’s total purchases made during a specific period; it is intended to encourage customer loyalty. 4. Suppose that Target wants to attract new customers to its stores by price lining its Archer Farms grocery items. Which of the following advertisements illustrates this new tactic? A. “Try our basic cereals for $1.99, deluxe cereals for 2.99, and ultimate cereals for $4.99!” B. “Buy 10 cartons of orange juice and get the 11th one for free!” C. “Spend $15 on coffee and receive a $5 rebate!” D. “For a limited time, all of our fruit is just $1.00 per pound!” E. “Buy any two deli meat packages and a loaf of bread for one low price!” Answer: A Price lining is the practice of offering a product line with several items at specific price points. 5. Best Buy’s low pricing strategy leads to a large number of products with low profit margins, meaning that this cost-oriented tactic is particularly useful during a period of inflation: A. Price shading. B. Delayed-quotation pricing. C. Elevator pricing. D. Escalator pricing. E. Culling products with a low profit margin. Answer: E One popular cost-oriented tactic is culling products with a low profit margin from the product line. GREAT IDEAS FOR TEACHING CHAPTER 19 Philip R. Kemp, DePaul University SURVIVAL BARTER EXERCISE Survival is a group exercise in which student teams must use the barter system to gather the necessary items in order to survive. Each group is given a list of six items on a sheet of paper or index card with the amounts of each item they must gather to survive (see Table 1). As seen in Table 1, a team may have the exact amount, a shortage, or an excess of goods in a category of what they need to survive. A team with an excess of goods in a particular category can use these excess goods to barter for other goods. The ideal size of each student team is five or six students; one member of the team is assigned the task of bookkeeper, and another is assigned the task of observer. At the end of the exercise, the bookkeepers report what their teams have accumulated through the barter of excess goods. The observers report on the dynamics that took place within the groups during the exercise One or two students should be asked to report on the dynamics of the whole exercise as it occurs. As shown in Table 1, each team must gather the exact same items and the same amount of each of these items. After the teams have been formed and the roles of bookkeeper, group observer, and overall observer have been assigned, the class is instructed that they have 20 minutes to complete the exercise. No additional assistance is provided by the instructor. After about 20–25 minutes, the exercise tends to end on its own. Hint: Move the class to an open area or arrange the room so that desks are at one side of the room. This will eliminate any physical barriers from interfering with the exercise. After the exercise is over, ask each bookkeeper to give an account of the items and amounts of each item his or her team has gathered. A matrix with teams on the top and items on the side serves as an excellent visual aid to show the national accounts (see Table 1). The class is informed that the only way a team can win is under the following conditions: first they must have gathered all the necessary items in the amounts necessary to survive (excess goods are acceptable), no goods at the macro level can have been lost or created. Teams have been able to gather the necessary goods in the correct amounts, but there is always some loss or gain of goods when the national accounts are totaled. After the national accounts have been shown, ask this question of the class: What would have helped you to accomplish your teams’ survival in this exercise? The usual answers to this question are: • better communications • currency or money • knowing the value of one item in relationship to other items • a central market • (in some rare cases) a middleman All of these responses then can lead into a discussion of the exchange function, central markets, the function of money within an economy, and how middlemen can assist in increasing the efficiency of the marketplace. When the discussions of a central market or middlemen are introduced ask the team observers and the overall exercise observers to describe the dynamics of what occurred in the groups and exercise as a whole. Every time I’ve done the exercise, the same dynamic emerges. The overall exercise dynamic usually runs as follows: Team members gather in their respective groups, then one member of the team goes to other teams to determine what they have to trade (excess products). They soon realize that sending out one person is too slow a process. They then decide to send out other members to talk to different groups to barter their excess goods. (This is the time when goods are created and lost at the Marco level.) When more than one team member is sent out of the group, typically a central market forms (all the teams gather in a section of the room, which looks like the trading floor of a commodities exchange pit). Finally, the central marketplace disbands and the teams then reform. Using diagrams on the blackboard with circles as the groups and lines with arrows as the traders, one can show the exchange process that takes place in a barter market. Then add to the diagram the other “runners” coming from each group. This diagram shows the formation of the central market; one can just use a large circle around all six groups on the board. I have become so bold as to draw these diagrams on a flip chart and just turn the pages as the observers describe the dynamics of the exercise. These diagrams are useful to introduce and discuss the topics of communication (promotion), central markets, and functions of middlemen. The exercise has benefits beyond instruction: • It an excellent icebreaker for the first class meeting. • It is an icebreaker for students to introduce themselves to one another. • If class discussion is important to you, it sets the tone for the rest of the term. • It is far superior to just passing out the syllabus and starting to lecture on a topic when the students have not had the opportunity to read the textbook. Table 1 TEAM 1 YOU NEED THE FOLLOWING YOU NOW HAVE THE FOLLOWING 3 CORDS OF WOOD 1 CORD OF WOOD (–2) 200 LBS. OF MEAT 350 LBS. OF MEAT (+150) 6 PAIRS OF BOOTS 4 PAIRS OF BOOTS (–2) 100 BUSHELS OF WHEAT 150 BUSHELS OF WHEAT (+50) 250 LBS. OF VEGETABLES 200 LBS. OF VEGETABLES (–50) 1 COOK STOVE 2 COOK STOVES (+1) TEAM 2 YOU NEED THE FOLLOWING YOU NOW HAVE THE FOLLOWING 3 CORDS OF WOOD 1 CORD OF WOOD (–2) 200 LBS. OF MEAT 50 LBS. OF MEAT (–150) 6 PAIRS OF BOOTS 7 PAIRS OF BOOTS (+1) 100 BUSHELS OF WHEAT 200 BUSHELS OF WHEAT (+100) 250 LBS. OF VEGETABLES 200 LBS. OF VEGETABLES (–50) 1 COOK STOVE 1 COOK STOVE TEAM 3 YOU NEED THE FOLLOWING YOU NOW HAVE THE FOLLOWING 3 CORDS OF WOOD 2 CORDS OF WOOD (–1) 200 LBS. OF MEAT 250 LBS. OF MEAT (+50) 6 PAIRS OF BOOTS 7 PAIRS OF BOOTS (+1) 100 BUSHELS OF WHEAT 50 BUSHELS OF WHEAT (–50) 250 LBS. OF VEGETABLES 200 LBS. OF VEGETABLES (–50) 1 COOK STOVE 1 COOK STOVE TEAM 4 YOU NEED THE FOLLOWING YOU NOW HAVE THE FOLLOWING 3 CORDS OF WOOD 5 CORDS OF WOOD (+2) 200 LBS. OF MEAT 400 LBS. OF MEAT (+200) 6 PAIRS OF BOOTS 5 PAIRS OF BOOTS (–1) 100 BUSHELS OF WHEAT 50 BUSHELS OF WHEAT (–50) 250 LBS. OF VEGETABLES 200 LBS. OF VEGETABLES (–50) 1 COOK STOVE 0 COOK STOVE (–1) TEAM 5 YOU NEED THE FOLLOWING YOU NOW HAVE THE FOLLOWING 3 CORDS OF WOOD 3 CORDS OF WOOD (+1) 200 LBS. OF MEAT 50 LBS. OF MEAT (–150) 6 PAIRS OF BOOTS 9 PAIRS OF BOOTS (+3) 100 BUSHELS OF WHEAT 0 BUSHELS OF WHEAT (–100) 250 LBS. OF VEGETABLES 350 LBS. OF VEGETABLES (+10) 1 COOK STOVE 2 COOK STOVES (+1) TEAM 6 YOU NEED THE FOLLOWING YOU NOW HAVE THE FOLLOWING 3 CORDS OF WOOD 5 CORDS OF WOOD (+2) 200 LBS. OF MEAT 100 LBS. OF MEAT (–100) 6 PAIRS OF BOOTS 4 PAIRS OF BOOTS (–2) 100 BUSHELS OF WHEAT 150 BUSHELS OF WHEAT (+50) 250 LBS. OF VEGETABLES 350 LBS. OF VEGETABLES (+100) 1 COOK STOVE 0 COOK STOVE (–1) NATIONAL ACCOUNTS (KEY) TEAM 1 TEAM 2 TEAM 3 TEAM 4 TEAM 5 TEAM 6 TOTAL WOOD 3 3 3 3 3 3 18 MEAT 200 200 200 200 200 200 1200 BOOTS 6 6 6 6 6 6 36 WHEAT 100 100 100 100 100 100 600 VEG. 250 250 250 250 250 250 1500 OVEN 1 1 1 1 1 1 6 Laura Balus, Central Community College PRICING: AN ART OR A MATHEMATICAL FORMULA? To introduce pricing, I gather various products from my home and office. Some of these products include grocery items, toys, office equipment, and computer software. Various products were ordered through a mail-order catalog and others were beauty items purchased through a home party. All of these items are arranged on a long table at the front of the classroom. All price tags have been removed. In preparation for this activity, I completed small recipe cards that individually listed specifics on each product and the purchase price. I announce to the class that I am conducting a silent auction of sorts. Each student is asked to file by the table of products and write down what each believes to be the purchase price of each product. When the students have returned to their seats, I divide the class into two teams. I explain that we will play a version of the popular television game show, The Price Is Right. Members of each team take turns at being either the game show host or the contestant. The game show host selects one product from the table and the accompanying recipe card of information and orally presents a brief description of the product and its many uses and benefits. Then the price guessing begins. The contestant is given 30 seconds to randomly call out prices, with the game show host responding with “higher” or “lower” until the correct price is announced. The excitement increases with each round of price guessing until all of the products are used. Guessing the correct price within 30 seconds earns each team a point. Points are tallied, and the losing team (the team with fewer points) is asked to bring treats for the whole class. The activity proceeds with an explanation of how pricing is indeed a game in itself. I refer to our study of the consumer’s “black box” and how research and creativity go hand-in-hand when establishing price. Indeed, mathematical pricing formulas are used with careful planning to cover the cost of goods, overhead, and retain a profit. However, I further explain that a price tag should not reflect wishful thinking. Pricing must revolve around the consumers’ innate sense of value. I stress to the class that our silent auction resulted in quite extreme price differences between class members, which was revealed with our game show rendition. Finally, I provide an overview of the numerous pricing strategies commonly used in today’s marketplace, with emphasis on how many of these strategies are intended to psychologically persuade consumers to buy. PART 6 – Integrated Case Assignments MARKETING MISCUE 6PM.COM’S $16 MILLION PRICING ERROR Upon arrival at the 6pm.com Web site, customers are immediately congratulated for the smart shopping skills that led them to the site. With brands such as Nike, Oakley, Nine West, Stride Rite, Columbia, and Diesel at discount prices, the Web site is a mecca for brandaholics seeking discounted merchandise. The online site offers products for all family members. The female shopper in the family is enticed with casual and contemporary fashion styles, as well as top-notch performance gear. The male shopper is presented with everything from performance to business casual to dress-for-success attire. Parents are encouraged to avoid the hassle of taking the kids to the store by shopping conveniently online. On 6pm.com, the promise is to have this wonderful brand shopping experience at up to 75 percent off retail prices. This delivery promise was well-heeded when a pricing snafu led to everything on the site being priced at $49.95. Zappos.com Zappos.com started as an online shoe retailer. The idea was to create a Web site that offered the best shoe selection in terms of brands, styles, colors, sizes, and widths. Since the company’s origination, the goal has broadened to one in which the company provides the best online service in many product categories. With fast and high-quality customer service as its mantra, ten years later the company is now comprised of ten separate companies under the Zappos Family umbrella: Zappos.com, Inc. (“the management company”) Zappos IP, Inc. (“ZiP”) Zappos Development, Inc. (“Zappos.com or ZDev”) Zappos Merchandising, Inc. (“ZMerch”) Zappos Fulfillment Centers, Inc. (“ZFC”) Zappos CLT, Inc. (“ZCLT”) Zappos Insights, Inc. (“ZInsights”) Zappos Gift Cards, Inc. (“ZGift Cards”) Zappos Retail, Inc. (“ZRetail”) 6pm.com, LLC (“6pm”) The rapidity at which the company has grown is attributed in no small part to its CEO Tony Hsieh (pronounced Shay). In 1999, Hsieh sold the company he co-founded to Microsoft for $265 million. Joining Zappos.com as an advisor and investor, Hsieh later became the company’s CEO and helped grow the company to over $1 billion in gross merchandise sales annually. In November 2009, Zappos.com was acquired by Amazon .com in a deal valued at $1.2 billion. The passion for service was the common connection between Zappos.com and Amazon.com. This passion for service is exemplified in the core values at Zappos.com: • Deliver WOW through Service • Embrace and Drive Change • Create Fun and a Little Weirdness • Be Adventurous, Creative, and Open-Minded • Pursue Growth and Learning • Build Open and Honest Relationships with Communication • Build a Positive Team and Family Spirit • Do More with Less • Be Passionate and Determined • Be Humble Delivering on these Values at a Very High Price! In the wee hours of a May morning in 2010, the Zappos-owned 6pm.com e-commerce site had a major glitch in its pricing engine. Everything on the 6pm.com Web site was priced at $49.95 from midnight to 6 a.m. For example, a GPS system that normally sold for nearly $2,000 was sold for $49.95. A pair of Bruno Magli boots that usually sold on 6pm.com for $400 sold for $49.95. The pricing glitch affected products sold only on the 6pm .com site and not products available on both 6pm.com and Zappos.com. The pricing mistake was attributed to an employee error in entering data into the pricing engine. Hsieh explained the pricing error on a company blog. He said that the current version of the pricing engine required near-programmer skills to manipulate and that a few symbols were missed in the coding of a new rule. Hsieh went on to say that, after this glitch, the internal pricing engine would be improved upon so that it would have a much easier user interface with business owners. Additional checks and balances would also be added to further prevent the error from ever occurring again. Interestingly, the employee responsible for the programming error was not fired. During the six hours of selling everything for $49.95, much of which was below cost, Zappos.com lost $1.6 million. While the terms and conditions on the company’s Web site state that the company does not need to fulfill orders that are placed due to pricing mistakes, Hsieh felt as though it was the right thing for the company to do by honoring customers’ orders at the noted price. Interestingly, Amazon.com, the parent company of Zappos.com, did not share this same policy when it experienced a similar pricing glitch a few months prior. In that instance, Amazon.com cancelled any orders that had not been fulfilled and gave customers a $25 gift card instead of the books that had been ordered at the wrong price. Sources: 6pm.com, www.6pm.com; Zappos.com, www.zappos.com; Edward Moyer, “Zappos Sister Site Zapped by Pricing Glitch,” CNET, May 23, 2010, http://news.cnet.com/8301-1023_3-20005714-93.html; Marc Perton, “Zappos Eats $1.6 Million in Pricing Snafu,” Consumerist, May 24, 2010, http://consumerist.com/2010/05/zappos-eats-16-million-in-pricing-snafu.html. Open-ended questions 1. What is the relationship between demand and price for products on the 6pm.com e-commerce site? Answer: Evidently, there is a strong relationship between demand and price on the 6pm.com Web site. The relationship is clearly one in which demand increases as price decreases, and this is the genesis of 6pm’s success to date. 2. Should there be any legislation that requires companies to adhere to online prices even when posted in error? Answer: This is a difficult question to answer since it has to be viewed from both the online retailer’s and the consumer’s perspective. From the online retailer’s perspective, mistakes in programming can happen too easily, and working in cyberspace leaves an element of vagueness in and of itself (unlike the physical price tag on a product hanging in a bricks-and-mortar location). Legally, online retailers protect themselves against pricing errors (either of their own or by a miscreant) by including a clause that gives them an “out” should such a pricing error occur. For example, the terms and conditions on the 6pm.com Web site stated that the company did not need to fulfill orders that were placed due to pricing mistakes. From the consumer’s perspective, however, students might view the situation differently. Most students will say that they have taken a product to a cash register and had that product ring up at a higher price. When the price on the tag is then pointed out to the checker, the lower price (on the tag) is given the consumer. That seems to be standard operating procedure, and one might expect the same standard operating procedure for online retailers. It would be interesting to engage students in a discussion about the role of the government (via legislation) in the monitoring of online retailing. Issues from big brother to the expense associated with such monitoring (given the enormity of online retailing in the 21st century) are likely to arise. TRUE/FALSE 1. Given American Airlines demands that Orbitz and other middlemen use its Direct Connect, the carrier sees a satisfactory profit. Answer: False American Airlines penetration pricing and behavior are more indicative of profit maximization. 2. GDS evolved from YMS. Answer: True 3. The GDS systems that Orbitz and other middlemen use is an extranet. Answer: True 4. Critics say that Direct Connect will allow American Airlines to raise its prices whenever it wants. Answer: False Supply and demand and other variables (e.g., fuel prices) still determine what American Airlines charges and it will price it tickets to ensure the fewest empty seats accordingly. MULTIPLE CHOICE 1. American Airlines risks disappointing consumers who perceive Expedia and other middlemen as the go-to source for “great deals.” This is because consumers expect __________ when they buy tickets. A. reasonable competition B. a reasonable price C. little sacrifice D. satisfaction maximization E. all of the above Answer: A Value is based upon perceived satisfaction, that is, when consumers feel they have paid a “reasonable price.” 2. American Airline tickets are a commodity. If other agents can sell its tickets, then they have __________ that American Airlines does not have. A. status quo pricing B. competition C. a distribution D. supply and demand E. unit market share Answer: E American Airlines is clearly increasing its market share at the expense of middlemen, repeating a strategy it had used previously to squeeze out travel agencies. 3. The in-house reservation Direct Connect is the latest example of __________, long used by airlines. A. eliminating competition B. penetration pricing C. a yield management system D. a ticket shopping bot E. selling for the brand Answer: C First developed in the airline industry, yield management systems (YMS) use complex mathematical software to profitably fill unused capacity. 4. Expedia, Orbitz, Priceline, and travel agencies make their money off __________. A. commissions paid by the airlines to sell their tickets B. the profits they make by bulk ticket purchases from the airlines C. sophisticated scalping software D. fees the airlines pay to list tickets on GDS E. fees the airlines pay after a ticket is sold on the middlemen’s GDS Answer: E The GDS ticket-sale model enables travel agents to sell tickets and collect fees from the sale of tickets via the GDS. 5. By removing itself from GDS-type retailers, American Airlines will maximize its ability for all of the following except __________. A. to increase ticket revenue B. to decrease marginal cost C. two-part pricing D. comparison shopping E. bundling with hotels, rental car agencies, and the like Answer: D Ticket shoppers using Direct Connect will not be able to compare flights to other carriers. 6. By eliminating the number of online ticket shopping venues that sold its tickets, American Airlines improves __________. A. its status quo pricing B. its buyer dependence—those traveling in and out of its hubs C. its ability to absorb fuel costs D. its economies of scale E. all of the above Answer: E All of the above are improved by penetration pricing strategies that result in market share, more ways to compete, and more options to pass (or not pass) on costs to consumers. CRITICAL THINKING CASE WILL A NEW RESERVATION SYSTEM TRANSLATE TO HIGHER PRICES FOR TRAVELERS? American Airlines, one of the top three airlines in the United States and a major international carrier via strategic alliances with leading carriers around the world, was founded in 1930 as American Airways. As an innovative leader in air travel, American Airlines started the frequent-flyer program in 1981. Since then, every major airline in the world has adopted some form of a frequent-flyer program. In late 2010, American Airlines once again took the lead in an airline initiative that could change the way consumers search for and ultimately purchase airline tickets. In an effort to reduce distribution costs, gain greater control over the marketing of its airline tickets, and better meet customer expectations, American Airlines upgraded its reservation system. In making the upgrade, the company expected third-party travel operators such as Expedia, Orbitz, and Priceline to follow suit. The Reservation System Consumers want low fares while also having the ability to customize their itineraries. Plus, they want to do this themselves and not have to go through a travel agent. Via an in-house reservation system called Direct Connect, American Airlines will be able to present a variety of individualized options to consumers, including prices, flight schedules, seat upgrades, lounge access, faster check-in, hotel reservations, and car rentals. Direct Connect constitutes a wholesale shakeup of the traditional reservation process that has relied historically on Global Distribution Systems (GDS) such as Amadeus, Sabre, Worldspan, and Galileo. All of these global distribution systems were designed originally by airlines, but all are now operated by independent owners. Middlemen such as Expedia and Orbitz conduct business via a GDS and do not want to upgrade their reservation systems to models such as Direct Connect. However, the Direct Connect technology will enable airlines to bypass the GDS and avoid paying the GDS fees. Airlines stopped paying commissions to travel agents in the 1990s, but the GDS model enables travel agents to sell tickets and collect fees from the sale of tickets via the GDS. The Dispute In December of 2010, American Airlines announced that it would no longer do business with Orbitz. By making this move, Orbitz could no longer sell American Airlines tickets on its online booking Web site. At the heart of the dispute was that American Airlines wanted Orbitz to use Direct Connect instead of GPS. Orbitz refused to switch reservation processes, so American Airlines withdrew its tickets. Beating American Airlines to the punch, Expedia announced on January 1, 2011 that American Airlines tickets were no longer an option on Expedia.com. Following suit, Sabre dropped American Airlines’ ranking on it site thus making it difficult to find American Airlines fares on this GDS. Some say that the bottom line is that American Airlines wants travelers to buy directly from its Web site, such as the process utilized by Southwest Airlines. From a pricing perspective, the middlemen such as Orbitz and Expedia say that this will allow American Airlines to raise ticket prices since customers will not have easy access to competitive pricing information. These distributors are charging that American Airlines’ new Direct Connect model is anti-consumer and anti-choice. Conversely, American Airlines says that it will enable lower ticket prices since it will eliminate the cost of the middleman, contending that the GDS model used by online travel agencies prevents airlines from offering the lowest possible fares. The chief financial officer at US Airways said that his company agreed in principle with what American Airlines was doing, citing the importance of lower airline distribution costs. Yet, this competitive airline recently entered into an agreement with Expedia in which US Airways committed to offering all of the airline’s content on Expedia through the GDS model. It could be that competitive rivals see this as an opportune time to appear more customer-friendly, in the hopes of gaining customer affinity while American Airlines battles it out with the middleman. Sources: American Airlines, http://www.aa.com; Doug Cameron, “American Airlines wants Expedia, Orbitz to Come Around,” Wall Street Journal, January 5, 2011, http://online.wsj.com/article/SB100014240527487047231045760618917 46793776.html; Kirsten Cluthe, “American Airlines Battles Expedia and Sabre over Reservations,” PCMag.com, January 18, 2011, www.pcmag.com /article2/0,2817,2375900,00.asp; Jane Levere, “Who Wins in the Dispute between Airlines and Online Ticket Sites?” Daily Finance, February 1, 2011, www.dailyfinance.com/story/investing/who-wins-in-the-dispute-between-airlines-and-online-ticket-sites/19822771; Josh Lew, “Is American Airlines Ducking Competition?” LowFares.com, February 16, 2011, www.lowfares.com/blog/2011/02/16/american-airlines-orbitz-airfares; Hugo Martin, “American Airlines-Orbitz-Expedia Feud may affect Ticket Prices,” Los Angeles Times, February 7, 2011, http://articles.latimes.com/2011/feb/07/business/la-fi-0217-travel-briefcase-20110217; Reuters, “Expedia Dumps American Airlines Listings,” FoxBusiness, January 3, 2011, www.foxbusiness.com/personal-finance/2011/01/03/expedia-dumps-american-airlines-listings. Open-ended questions 1. Identify each channel member’s pricing objective. Answer: American Airlines: sales-oriented Retailer (e.g., Expedia, Orbitz, Priceline): profit-oriented The pricing objective for channel members appears to vary based on position in the channel. American Airlines juggles pricing on a daily basis so as to maximize sales. Ultimately, the goal is to have every aircraft take off with all seats filled. American Airlines wants to gain the largest market share and, as such, increase customer loyalty. The company wants customers to automatically go to the aa.com Web site because American Airlines is the preferred air travel provider. Ultimately, the sales-oriented objective turns into profit maximization. The online retailer, however, is likely seeking to attain a goal of profit maximization. The retailers want total revenue to be as large as possible relative to total costs. As such, upgrading to a new reservation system would increase costs; yet, the nature of competition (competing with other retailers as well as the airline itself) means increased costs without a simultaneous increase in sales revenue. Both American Airlines and the online retailers also engage in status quo pricing just by the nature of the fact that customers can shop around. However, it’s unlikely that status quo pricing is the objective of either channel member. 2. What is the American Airlines’ pricing strategy? Answer: American Airlines appears to follow a penetration pricing strategy. The constant juggling of prices to accommodate the filling of seats on an aircraft results in the company competing on price to the mass market. While there is lower profit per unit on some seat sales, it is better to have a seat filled at whatever the price than to have the seat revenue disappear due to taking off with empty seats. Penetration pricing also discourages competition, which appears to be occurring relative to the online retailers. American Airlines does not necessarily need the online retailer to sell its seats since customers can buy directly from the company. TRUE/FALSE 1. 6pm.com customers essentially shoplifted online by taking advantage of an honest mistake. Answer: False There was no price tag switching here! However, it is human nature to perceive the retailer as having unlimited resources. To the consumer, the price is the cost of something and not the many factors it is to the retailer. 2. The idea that “it’s too good to be true” did not stop people from buying. Consumers will always choose the lowest price. Answer: False The information effect of price was surely overridden by savvy customers who for the most part took a chance—like a lottery ticket—on seeing what benefit came from the mistake. 3. Amazon.com did not want to set the public relations precedent set by Tony Hsieh. Answer: True 4. Retailers contribute to the “door-buster” and “entitlement” behavior of customers when pricing mistakes are made. Answer: True MULTIPLE CHOICE 1. In many marketing textbooks, including this one, there is the principle that if a retailer sets the price too low, it will frustrate sales based on __________. The write-off of $1.6 million in merchandise proves otherwise given the context. A. customer satisfaction B. consumer law C. the price-is-right notion D. perceived reasonable value E. none of the above Answer: D In this case, the idea of “reasonable price” meaning “perceived reasonable value” is trumped by the human nature. 2. If one were to pick an explanation from economics for why 6pm.com customers took advantage of the programming error that priced every piece of merchandise at $49.95, it was too __________. A. avoid the sacrifice effect of price B. experience the pleasure of “cheating back” a large corporation C. see if the company would eat the loss D. join a class action suit E. all of the above Answer: A The sacrifice effect of price—what the consumer has to give up for a good or service—would be the purely economic reason for taking advantage of the $49.95 one-price-fits-all mistake. 3. What would be the retailing principle that compelled Tony Hsieh to ship merchandise that was grotesquely underpriced when he could have just cancelled the orders? A. every online sale is a legal sale, a contract between consumer and retailer B. customer satisfaction C. it would have cost more to settle in court D. the dollar amount lost is only retail, not wholesale E. the loss would be made up in future sales Answer: B Answer e is close—but maintaining customer satisfaction is indispensable for retailers. In this case, it would be those customers who ordered items at $49.95 and those who know that 6pm.com will even lose money to satisfy customers. 4. What really pays for the losses absorbed by 6pm.com? A. Amazon.com B. Amazon shareholders C. 6pm.com D. 6pm.com vendors E. none of the above Answer: E Ultimately, future profits made from future 6pm.com customers pay for the lost income—indeed, they were already paying for it before it happened since all companies factor in some kind of shrinkage costs (“expenses not otherwise accounted for”) into the markup. 5. By rewarding consumers who took advantage of the pricing mistake, what factor of human behavior did Tony Hsieh encourage about the shopping experience at 6pm.com? What made a mistake a promotion? A. feelings of entitlement B. the hedonistic effect C. a sense of fair play D. the allocative effect E. all of the above Answer: B 6pm.com is designed to be a fun shopping experience. So, Hsieh actually used the accidentally low purchase prices of the merchandise into a hedonistic consumption event that intensifies 6pm.com’s reputation as a fun place to shop, to reward yourself. 6. Choose the most plausible reason that marketing manager might rationalize giving away $1.6 million in merchandise? A. Ultimately, long-term profit goals had to be considered, not a short-term loss. B. It is still the right thing to do and no point second guessing Tony Hsieh. C. The company seeks only a satisfactory profit motive. D. People need a break from the recession. E. So consumers did not feel like they were paying a penalty. Answer: A The $1.6 million can be seen as one of those trade-offs that managers must weigh to achieve profit maximization. It is that important notion of careful management after a mistake or setback. Part 6, Ch. 19, Pricing Concepts: How supply-demand economics, e-commerce, and new hires could affect L.L.Bean’s prices. Below are three recent examples of how pricing can affect L.L.Bean’s business: • As of November 2015, L.L.Bean’s customers were once more put on a waiting list to receive their L.L.Bean boots. After the same situation the prior year, the company had hired and trained more workers to make the boots, and also installed a second machine to craft the rubber boot bottoms. In spite of these changes, L.L.Bean is struggling to find a balance between the product demands of its customers and increasing production at a sustainable rate to avoid a surplus of boots, which would drive down their retail value. • E-commerce has exploded in popularity among companies and consumers. E-commerce is an obvious choice for companies like L.L.Bean because it cuts down on the printed materials and postage required by catalog ordering. However, a few years ago the company got a lesson in the pitfalls of e-commerce when it incorrectly noted the price of a tote bag as $19 instead of $169 on its online store. The story went beyond lost profits and frustrated customers; it also negatively impacted four L.L.Bean workers who were erroneously fired for purchasing the deeply discounted tote bags. L.L.Bean later publicly apologized for firing the workers and rehired them, stating that the company would put into place a better strategy for rectifying pricing mistakes. • In November 2015, L.L.Bean hired Steve Smith to replace retiring CEO Chris McCormick. In the past, McCormick had gone on record to say that L.L.Bean’s boots and other products would always be made in Maine. Part of L.L.Bean’s pricing strategy is justified by the company’s decision to create high-quality, American-made products. However, L.L.Bean’s new CEO comes from Walmart International, where he worked as chief marketing and merchandising officer in China. Walmart is not known for having high prices, high-quality products, or an American-made mentality. It will be interesting to track how Smith’s background affects L.L.Bean’s future production choices and pricing options. Sources: Luna, T., “Despite New Staff, Bean Boots Are Backlogged Again,” Boston Globe, November 19, 2014, https://www.bostonglobe.com/business/2015/11/18/llbean/yMI2AzijIeNfnPiIbi00MN/story.html. McIntire, D., “New L.L. Bean CEO Makes the Rounds,” Times Record, November 10, 2015, http://www.timesrecord.com/news/2015-11-09/Front_Page/New_LL_Bean_CEO_makes_the_rounds.html. Washuk, B., “L.L. Bean Rehires Workers Fired in Pricing Dispute,” Boston Globe, June 30, 2011, https://www.bostonglobe.com/business/2015/11/18/llbean/yMI2AzijIeNfnPiIbi00MN/story.html. Solution Manual for MKTG: Principles of Marketing Charles W. Lamb, Joe F. Hair, Carl McDaniel 9781305631823, 9781285860145, 9781337116800
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