Pricing Concepts

1. 11 Pricing Concepts

2. Learning Objectives • After studying this chapter, you should be able to: • Realize the importance of price and understand its role in the marketing mix. • Understand the characteristics of the different pricing objectives that companies can adopt. • Identify many of the influences on marketers’ pricing decisions. • Explain how consumers form perceptions of quality and value. • Understand price–quality relationships and internal and external reference prices.

3. Wal-Mart • Wal-Mart stores are known for their size, assortment of brands and product categories, and low prices. In the fiscal year ending January 31, 2005, Wal-Mart Stores, Inc., the world’s largest retailer, had $285.2 billion in sales with more than 3,600 stores in the United States and more than 1,500 stores outside the United States.

4. Tuition Fees Interest Payments Fines Rents Premiums Taxes Donations Time List Prices Partitioned Prices The Role of Price • Price is the amount of money a buyer pays to a seller in exchange for products and services. It reflects the economic sacrifice a buyer must make to acquire something. This is the traditional economic concept of price, called the objective price. • Other labels for prices are:

5. Price Mix • The basic price mix includes those components that define the size and means of payment exchanged for goods or services. • The price promotion mix includes supplemental components of price, which aim at encouraging purchase behavior by strengthening the basic price mix during relatively short periods. Exhibit 11-1

6. Pricing Decisions • Price elasticity of demand is the responsiveness of demand to changes in price. • Both the importance and difficulty of pricing decisions have increased in recent years. • Introduction of look-alike products increases sensitivity to small price differences. • Internet access to price and competitive information has made price comparisons easier and has increased pressures on prices. • Demand for services, which are labor-intensive, hard to price, and sensitive to inflation, has increased. • Increased foreign competition particularly from economies with low labor costs like chains, has placed added pressure on firms’ pricing decisions.

7. Pricing Decisions (con’t) • Changes within the legal environment and economic uncertainty have made pricing decisions more complex. • Shifts in the relative power within distribution channels from manufacturers to retailers, who are more price-oriented, also has increased the importance of price decisions. • A bottom-line emphasis places more pressure on performance. Price reductions boost short-term earnings more effectively than does advertising. • Technology that has reduced the time from new product idea generation to production also shortens the average life span of products.

8. Benefits of Price Promotions • Stimulate retailer sales and store traffic. • Enable manufacturers to adjust to variations in supply and demand without changing list prices. • Enable regional businesses to compete against brands with large advertising budgets. • Reduce retailer’s risk in stocking new brands by encouraging consumer trial and clearing retail inventories of obsolete or unsold merchandise. • Satisfy trade agreements between retailers and manufacturers. • Stimulate demand for both promoted products and complementary (nonpromoted) products. • Give consumers the satisfaction of being smart shoppers who are taking advantage of price specials.

9. Limits to Price Setting Exhibit 11-3

10. New Product Pricing Decisions • The answers to the following questions enhance the ability of firms to make final new product pricing decisions: • What new benefits can prospective customers acquire from the innovation? • Which market segments will benefit from these new benefits the most? • What current problem solutions will be replaced? • What range of prices will be possible in the segments that will benefit the most? • Given this range of prices, what costs can be afforded? • What complementary products are associated with use of the new introduction? • How can the innovation’s benefits and price be communicated?

11. Global Pricing Considerations • Pricing in international markets is particularly difficult. Firms pursuing global opportunities find that prices for the same item can be extraordinarily different across countries, even within countries; prices seem to be driven by different dynamics in each situation. Exchange Rate The price of one country’s currency in terms of another country’s currency Protective Tariffs Taxes levied on imported products to raise the prices of those products in efforts to keep local prices competitive.

12. Pricing Objectives • Five Objectives Guide Pricing Decisions: • Ensuring market survival. • Enhancing sales growth. • Maximizing company profits. • Deterring competition from entering a company’s niche or market position. • Establishing or maintaining a particular product quality image.

13. Sales Growth Penetration Pricing Penetration pricing is often the strategy used to accomplish this objective. Firms set penetration prices low to encourage initial product trial and generate sales growth, often as part of market entry strategies. Market Share Market share describes the firm’s portion, or percentage, of the total market or total industry sales. Price setting to maximize market share is similar to price setting in pursuit of sales growth.

14. Profitability • Profit maximization requires complete understanding of cost and demand relationships; and estimates of cost and demand for different price alternatives are difficult to obtain. Exhibit 11-4

15. Profitability Price Skimming Price skimming is a strategy often associated with profit maximization. It includes setting prices high initially to appeal to consumers who are not price sensitive. Return on Investment Profitability is often related to return on investment (ROI). ROI is the ratio of income before taxes to total operating assets associated with the product, such as plant and equipment and inventory.

16. Competitive Pricing • Competitive strategies are arrayed on a continuum labeled the competitive strategy-positioning continuum. This continuum is anchored by “lowcost leadership” on one end and “differentiation” on the other. Price Competition Price competition occurs most often when the competing brands are very similar, or when differences between brands are not apparent to prospective buyers. Nonprice Competition In nonprice competition, the firm attempts to develop buyer interest in benefits such as quality, specific product features, or service.

17. Five Cs of Pricing • To ensure that pricing decisions are effective and consistent with the firm’s objectives, marketers should consider the five Cs of pricing shown below: Exhibit 11-5

18. Costs • Costs associated with producing, distributing, and promoting a product or service are instrumental in establishing the minimum price or floor for pricing decisions. Exhibit 11-6

19. Customers • Customer expectations and willingness to pay are important influences on pricing decisions. • Target costing, a concept developed in Japan, combines both cost and customer input into price decisions. The process results in a market-driven cost estimation procedure to determine for a product what the manufacturing costs must be to achieve: • the profit margin the company desires • the features sought by customers • the prices that will be attractive to potential buyers.

20. Channels, Competition, Compatibility Channels of Distribution Prices must be set so that other members of the channel of distribution earn adequate returns on sales of the firm’s products. Competition Prices charged by competing firms and the reaction of competitors to price changes influence pricing decisions. Compatibility The price of a product must be compatible with the overall objectives of the firm.

21. Ethical and Legal Restraints • Marketers must consider more than the influences of the five Cs in price decisions. Pricing practices must also conform to laws and regulations and ethical expectations of customers and society in general.

22. Dumping Dumping Dumping is selling a product in a foreign country at a price lower than its price in the domestic country, and lower than its marginal cost of production. Predatory Dumping Predatory dumping is pricing intended to drive rivals out of business. A successful predator firm raises prices once the rival is driven from the market.

23. Primary Implications of Legislation • Horizontal price fixing among companies at the same level of a distribution channel is illegal. • In most cases, retailers are free to establish their own final selling prices. Prices charged by manufacturer- or wholesaler-owned retailers may still be restricted by the owner. • Some states have enacted minimum price laws that prevent retailers from selling merchandise for less than cost. • Prices must not be presented in a way that deceives customers. • Discrimination that reflects extremely low prices to eliminate competition, or that does not reflect cost differentials, may be illegal. • In industries with a few large firms, it is generally acceptable for the pricing behavior of smaller firms to parallel that of larger firms.

24. International Agreements • General Agreement on Tariffs and Trade (GATT). • The Organization of Petroleum Exporting Countries (OPEC). • The European Union (EU). • The North American Free Trade Agreement (NAFTA).

25. Perceived Value • Perceived value describes the buyer’s overall assessment of a product’s utility based on what is received and what is given. Exhibit 11-8

26. Consumer Evaluations of Prices Exhibit 11-9

27. Comparison Prices • Advertisers often provide comparison prices (external reference prices) to persuade shoppers to buy. Exhibit 11-10

28. Summary • After studying this chapter, you should be able to: • Realize the importance of price and understand its role in the marketing mix. • Understand the characteristics of the different pricing objectives that companies can adopt. • Identify many of the influences on marketers’ pricing decisions. • Explain how consumers form perceptions of quality and value. • Understand price–quality relationships and internal and external reference prices.