Building the Price Foundation and Arriving at the Final Price

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Building the Price Foundation and Arriving at the
Final Price

• John T. Drea
• Associate Professor of Marketing
• Western Illinois University

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Who influences price decisions?
Customers
Competitors
Government
Stakeholders
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Who Influences Pricing Decisions?
Customers

• Customers determine elasticity
• the change in the quantity demanded divided by
  the change in price
• Brand differentiation can help create inelasticity

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Who Influences Pricing Decisions?
Customers

• You need to know the contributions each channel
  member will add to the final cost of the product.
• Price Cost/(1 - markup)

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Who Influences Pricing Decisions?
Customers

• QuestionYour company produces a pair of jeans
  for 15 cost. Your markup to the wholesaler is
  20, the wholesalers markup to the retailer is
  15, and the retailers markup is 40. What is
  the selling price for the jeans at each stage?

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Who Influences Pricing Decisions?
Customers

• Price Cost/(1 - markup)
• Manufacturer Price 15/(1 - 0.2) 18.75
• Wholesaler Price 18.75/(1 - 0.15) 22.06
• Retailer Price 22.06/(1 - 0.40) 36.76
• What if the market will not support 36.76?
• reduce your cost
• reduce your markup
• convince other channel members to reduce markups
• convince consumers the jeans are worth 36.76

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Who Influences Pricing Decisions?
Competitors

• Direct competitors (Whirlpool vs. Maytag, TWA vs.
  United Airlines)
• Indirect competitors (Duncan Hines vs. a local
  bakery, TWA vs. Amtrak)
• Competitors are a dynamic ingredient in pricing

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Who Influences Pricing Decisions?
Government

• Price fixing
• Price discrimination
• Price regulation and deregulation

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Who Influences Pricing Decisions?
Stakeholders

• Individuals with a vested interest in the
  financial performance of the organization
• Pricing is the one element which has a direct
  impact on financial performance.

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Types of Pricing Objectives

• adding a specified percentage to the cost of each
  item
• easy and well-accepted in some industries
• doesnt reflect market conditions

Cost Plus Pricing Objective
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Types of Pricing Objectives

• charging prices in-line with major competitors
• common among small businesses who seek to compete
  on non-price factors
• may not reflect organizational revenue/profit
  needs

Status Quo Pricing Objective
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Types of Pricing Objectives

• specifying a desired rate of return, then pricing
  all products to achieve that rate of return
• attractive to shareholders - keeps organizational
  needs in mind
• may not reflect competitor actions - can lead to
  over-pricing or under-pricing

Target Rate Of Return Pricing Objective
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Types of Pricing Objectives

• pricing to maximize total profit
• attractive to shareholders
• potentially short-sighted

Profit Maximization Pricing Objective
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Types of Pricing Objectives

• Market share leadership is often related to
  profitability
• Requires the ability to withstand period of low
  or negative profits, both financially and
  politically
• Requires a dose of realism - Can you hope to
  achieve a dominant position?

Market Share Pricing Objective
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Psychological Pricing Issues

• Do consumers believe that higher priced good are
  of a higher quality?
• It depends.
• Price is an informational input into the
  determination of quality

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Psychological Pricing Issues

• Does Bundle Pricing Work?
• It depends.
• Effective when all bundle components are
  desirable to the consumer and the bundle creates
  value.
• Alternatives
• Control over complimentary products (we sell
  both)
• Cross-subsidization (we sell one to sell the
  other) Issues cherry-picking and buyer
  vertical integration

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Value-based pricing

• Prices are set to reflect the value a consumer
  derives from a product relative to competitive
  offerings.
• It doesnt necessarily mean a lower price - it
  may involve lower initial price, but it may also
  involve lowering life cycle costs for the buyer,
  reducing perceived risk, increasing benefits (ex
  bundling).
• What is the product worth to the consumer?

Source Lamb, Charles W. Jr., Joseph F. Hair,
Jr., and Carl McDaniel (1998). Marketing, 4th
Edition. Cincinnati South-Western.
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Life cycle costs influence price setting

• The longer the expected product life, the greater
  the importance of life cycle costs.
• Some companies can charge a premium price and
  command a large share due to lower life cycle
  costs.
• HP (printers)
• Caterpillar

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Determining Prices Assume...

• 80,000 of fixed costs, 10 variable costs/unit
• Estimated demand
• 20,000 units at 16/unit 320,000 sales
• 10,000 units at 24/unit 240,000 sales
• 5,000 units at 35/unit 175,000 sales

80,000/20,000 4 FC 10 VC 14 cost
40,000 profit 80,000/10,000 8 FC 10 VC
18 cost 60,000 profit 80,000/5,000 16 FC
10 VC 26 cost 45,000 profit
What does this suggest for a Cost-plus strategy?
Profit maximization? Market share? To use
status quo pricing, you need to know competitor
prices. To use value-based pricing, you also need
to know the benefits derived from your product
relative to competitors.
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Example
Acme has 100,000 of fixed costs, variable costs
of 20/unit, and has estimated demand as
follows
10,000 units _at_ 25/unit 9,000 units _at_
35/unit 6,000 units _at_ 45/unit 4,000 units _at_
50/unit
Two existing competitors are priced at 32 and
40, but they both deliver substantially less
benefits than Acmes product.. What price would
you recommend Acme charge, and what
questions/steps do you need to ask to determine
this?
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New product pricing strategies

• setting a high price when introducing a product.
  It is appropriate when
• the product has a strong relative advantage
• demand is inelastic (not elastic)
• competition is not anticipated (the product is
  difficult to copy)
• the total market is not expected to be large

New Product Pricing Skimming Strategy
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New product pricing strategies

• setting prices low and using other elements of
  the marketing mix (product/promotion/
  distribution) to reach a mass audience. It is
  appropriate when
• Product does not have a signif. relative
  advantage
• Significant economies of scale are possible.
• Demand is expected to be highly elastic.
• Strong competition is anticipated.

New Product Pricing Penetration Strategy