Pricing Products: Pricing Considerations and Strategies

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CHAPTER 7

• Pricing Products Pricing Considerations and
  Strategies
• Objective looking at the factors when setting
  prices and examining the pricing strategies by
  focusing on the problem of setting prices.

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Factors to Consider When Setting Prices

• A companys pricing decisions are affected by
• internal company factors
• external environmental factors

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Internal Factors Affecting Pricing Decisions

• Internal factors that affect pricing decisions
  include
• the companys marketing objectives
• marketing-mix strategy
• costs
• organization

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Marketing Objectives

• Before setting a price, the company must decide
  on its overall strategy (target market, and
  positioning, then its marketing mix). E.g. if a
  car manufacturer decides to produce a new sports
  car for the high-income segment, then the company
  must charge a high price.
• Then the company must consider its objectives,
  before setting its price. Objectives would be
• survival if a company is in trouble because over
  capacity, heavy competition, or changing consumer
  wants, in order to survive and increase demand,
  the

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• company may set a low price. Here, the profits
  are less important than survival. If the prices
  cover the costs, they can stay in business but
  survival is only a short-term objective.
• current profit maximization some companies
  estimate what demand and costs will be at
  different prices and choose the price that will
  produce the maximum current profit. Here,
  short-term financial results (cash flow) are more
  important than long-run performance.
• market-share leadership some companies believe
  that the company with largest market share will
  enjoy the lowest costs and highest long-run
  profit. That is why, in order to become the
  market-share leader, they set their prices as low
  as possible.
• product-quality leadership if a company wants to
  become the product-quality leader, it charges a
  high price to cover the costs of RD.

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Marketing-Mix Strategy

• Decisions made for the other marketing mix
  variables affect pricing decisions. The marketer
  must consider the total marketing mix when
  setting prices.
• There are two alternatives. Either price
  positioning determines the products marketing
  mix or nonprice positioning determines the
  products marketing mix.
• In price positioning the company makes its
  pricing decision first and then makes other
  marketing-mix decisions on the prices that they
  want to charge. This

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• technique is called target costing which
  reverses the usual process of first designing a
  new product, determining its cost, and then
  asking the consumers how much they can pay for
  it. Instead it starts with a target cost and
  price in mind and works back. E.g. Compaq
  Computer Corporation calls this process design
  to price. Starting with a price target set by
  marketing, and with profit margin goals from
  management, the company determine what costs had
  to be in order to charge the target price for its
  Prolinea personal computer line.
• In nonprice positioning the company deemphasize
  price and use other marketing-mix tools to
  differentiate the marketing offer to make it
  worth a higher price. They believe that the best
  strategy is not to charge the lowest price
  because customers do not buy on price alone.
  Instead they seek products that give them the
  best value for their money.

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Costs

• Costs set the floor for the price that the
  company can charge for its product. The company
  wants to charge a price that both covers all its
  costs for producing, distributing, and selling
  the product and provides a fair profit.
• A companys costs are two types fixed and
  variable.

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• Fixed costs (also known as overhead) are those
  that do not vary with production or sales level
  e.g. rent, interest, heat, executive salaries.
• Variable costs vary directly with the level of
  production e.g. supplies.
• Total costs are the sum of the fixed and variable
  costs for any given level of production.
• Management wants to charge a price that will at
  least cover the total production costs at a given
  level of production.

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Organizational Considerations

• Management must decide who will set the prices in
  the company.
• In small companies, prices are set by the top
  management.
• In large companies prices are set by divisional
  or product line managers.
• In industrial markets, salespeople may be allowed
  to negotiate with customers within certain price
  ranges set by the top management.
• In industries where pricing is a key factor
  (railroads, oil companies) there are pricing
  departments reporting to the marketing department
  or top management.

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External Factors Affecting Pricing Decisions

• External factors that affect pricing decisions
  include
• the nature of the market and demand
• competition
• other environmental elements

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The Market and Demand

• Before setting prices, the marketer must
  understand the relationship between price and
  demand for its product with the help of the
  following
• pricing in different types of markets
• consumer perceptions of price and value
• analyzing the price-demand relationship

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Pricing in Different Types of Markets

• The sellers pricing freedom varies with
  different types of markets. Economists recognize
  four types of markets which require different
  pricing methods.
• under pure competition the market consists of
  many buyers and sellers trading in a uniform
  commodity such as wheat, copper No single buyer
  or seller has much effect on the going price. A
  seller cannot charge more than the going price
  because buyers can obtain as much as they need at
  the going price. A seller cannot charge less as
  well, because they can sell all they want at this

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• price. Here, marketing research, product
  development, pricing, advertising and sales
  promotion play little or no role.
• under monopolistic competition the market
  consists of many buyers and sellers who trade
  over a range of prices than a single market
  price. A range of prices occurs when buyers see
  differences in sellers products and are willing
  to pay different prices form them. Sellers try to
  develop differentiated offers (with advertising,
  branding) for different customer segments.
• under oligopolistic competition the market
  consists of a few sellers who are highly
  sensitive to each others pricing and marketing
  strategies. The product can be uniform (steel,
  aluminum...) or nonuniform (cars, computers).
  There are few sellers because it is

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• difficult for new sellers to enter the market.
  Each seller is alert to competitors strategies
  and moves. If a steel company decreases its price
  by 10 percent, buyers quickly switch to this
  supplier. So that the other steelmakers must
  respond by lowering their prices or increasing
  their services. Here it is not certain that they
  will get permanent results through such price
  cuts.
• In a pure monopoly, the market consists of one
  seller. It would be a government monopoly, a
  private regulated monopoly, or a private
  nonregulated monopoly. Pricing is handled
  differently in each case. A government monopoly
  may have three objectives. (1) It might set a
  price below cost because the product is important
  for the buyers who cannot afford to pay full
  cost. (2) Or the price might be set either to
  cover costs

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• or to produce good revenue. (3) It can be set
  quite high to slow down consumption. In a
  regulated monopoly, the government permits the
  company to set rates (but that should yield a
  fair return). In a nonregulated monopoly, the
  company is free to set a price at what the market
  will bear. But they may not charge the highest
  price for a number of reasons (1) not to attract
  competition, (2) to penetrate the market faster
  with a low price, or (3) to prevent government
  regulation.

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Consumer Perceptions of Price and Value

• The consumer decides whether a products price is
  right. That is why, pricing decisions are buyer
  oriented like the other marketing-mix decisions.
• Effective buyer-oriented pricing involves
  understanding how much value consumers give to
  the product and setting a price that fits this
  value. But is not easy to measure the value
  (intangible values are included e.g. taste,
  environment, status) that consumers give to the
  product.
• If consumers perceive that the price is greater
  than the products value, they do not buy the
  product. If consumers perceive that the price is
  below the products value, they buy but then the
  seller loses from its profit opportunities.

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Analyzing The Price-Demand Relationship

• Each price that the company might charge will
  lead to a different level of demand.
• In the normal case, demand and price are
  inversely related the higher the price, the
  lower the demand.
• In the case of prestige goods, the demand curve
  sometimes slopes upward e.g. one perfume company
  found that by raising its price, it sold more
  perfume rather than less. Consumers thought that
  the higher price meant a better perfume.
• Most companies try to measure their demand curves
  by estimating demand at different prices.

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Price Elasticity of Demand

• Marketers need to know price elasticity - how
  responsive demand will be to a change in price.
  If demand hardly changes with a small change in
  price, we say that the demand is inelastic. If
  demand changes greatly, we say that the demand is
  elastic.
• Buyers are less price sensitive
• when the product is unique or high quality or
  prestige
• when substitute products are hard to find or when
  they cannot easily compare the quality of
  substitutes

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• when the total expenditures for a product is low
  relative to their income or when the cost of
  buying a product is shared by another party.
• If demand is elastic, sellers lower their price.
  A lower price produces more total revenue when
  the extra costs of producing and selling do not
  exceed the revenue.
• A. Inelastic demand
  B. Elastic Demand
• P2
  
  P2
• P1
  
  P1
• Q2 Q1
  
  Q2
  Q1
• Quantity demanded per period
  Quantity demanded per period
  

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Competitors Costs, Prices, and Offers

• Another external factor affecting the companys
  pricing decisions is competitors costs and
  prices and reactions to the companys own pricing
  moves.
• The companys pricing strategy may affect the
  nature of the competition e.g. if a company
  follows a high-price strategy, it may attract
  competition. A low-price strategy may stop
  competitors or drive them out of the market.
  Here, the company must learn the price and
  quality of each competitors offer and price its
  offer relative to competition.

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Other External Factors

• Some other factors must be considered when
  pricing
• economic conditions such as boom or recession,
  inflation, and interest rates affect pricing
  because they affect (1) the costs of production
  and (2) consumer perceptions of the products
  price and value.
• resellers should be considered in pricing
  because they should get a fair profit so that
  they help the company to sell its products.

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• government laws that affect pricing must be
  known so that the company makes sure that their
  pricing policies are defensible.
• social concerns the companys sales, market
  share, profit goals must be viewed by societal
  considerations.

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General Pricing Approaches

• Companies set prices by selecting a general
  pricing approach that includes one or more of the
  following factors (1) product cost, (2) consumer
  perceptions of the products value - demand, (3)
  competitors prices and other external and
  internal factors.
• Following pricing approaches are possible to use
• the cost-based approach (cost-plus pricing,
  break-even analysis, and target profit pricing)
• the buyer-based approach (value-based pricing)
• the competition-based approach (going-rate and
  sealed-bid pricing)

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Major Considerations in Setting Price
LOW PRICE No possible profit at this price
Product costs
Competitors prices and other external and
internal factors
Consumer perceptions of value
HIGH PRICE No possible demand at this place
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Cost-Based Pricing

• A) Cost-plus pricing markup pricing
• is the simplest pricing method in which a
  standard mark-up (profit margin) is added to the
  cost of the product e.g. the cost of producing a
  toaster is 16 and the producer wants to make a
  25 profit, therefore sets the price at 20.
• the biggest benefits of this approach is that
  when all the companies use this approach, price
  competition is minimized.

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• B) Break-even pricing or target profit pricing
• in which the firm tries to determine the price at
  which it will break even or make the target
  profit that it wants.
• Target pricing uses the concept of a break-even
  chart, which shows the total cost and total
  revenue expected at different sales volume
  levels.
• E.g. fixed costs are 6 million, variable costs
  are 5 per unit. The total revenue curve reflects
  the price. If the revenue is 12 million on
  800.000 units, the price is 15 per unit.

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• At the 15 price, the company must sell at least
  600.000 units to break even where the total
  revenues equal to total costs, 9 million. If the
  company wants to target 2 million profit, it
  must sell at least 800.000 units to obtain 12
  million total revenue needed to cover 10 million
  total costs.
• The higher the price, the lower the companys
  break-even point. But as the price increases,
  demand decreases. Although this approach helps
  the company to determine minimum prices needed to
  cover its expected costs and profits, they do not
  take the price-demand relationship into
  consideration.

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Break-even Chart for Determining Target Price
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Buyer-Based Pricing

• uses buyers perceptions of value as the key to
  pricing. Here, the marketer set the price based
  on the consumers desires and then design the
  product and the other marketing-mix variables.
• Cost-based pricing is product driven, but
  buyer-based pricing is consumer driven.
  Therefore, it begins with analyzing consumer
  needs and value perceptions.

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Competition-Based Pricing

• A) Going-rate pricing
• in which a firm bases its prices on competitors
  prices. The firm might charge the same, more or
  less than its competitors.
• Going-rate pricing is popular when elasticity of
  demand is hard to measure and when the firms do
  not want harmful price wars.

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• B) Sealed-bid pricing
• in which a firm bases its price on how it thinks
  that competitors will price. Here, the firm wants
  to win a contract and winning the contract
  requires pricing less than other firms.

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New-Product Pricing Strategies

• Pricing strategies usually change as the product
  passes through its life-cycle. At the
  introduction stage, basically there are two types
  of products - imitations of existing products and
  innovative patent-protected product.
• A company with an innovative patent-protected
  product has two pricing strategies
• Market-skimming pricing
• Market-penetration pricing

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Market-Skimming Pricing

• When a new product is introduced, the company
  charges the highest price that it can to skim (as
  skimming the cream on the top of the fresh milk)
  the market. The objective is to earn the highest
  possible gross profit. As initial sales slow
  down, and competitors start to introduce similar
  products, the company must lower its prices.

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• Here, the company skim off small but profitable
  market segments.
• Market skimming makes sense (1) when the
  products quality and image support its high
  price and enough buyers want it at that price,
  (2) when the costs of producing a smaller volume
  are not so high that they eliminate the
  advantages of charging more, (3) when competitors
  do not enter the market easily and cut the prices.

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Market-Penetration Pricing

• Market-penetration pricing is that setting a low
  price for a new product in order to attract a
  large number of buyers and a large market share.
• The high sales volume results in falling costs
  which helps the company to cut its price even
  more.
• Market-penetration makes sense (1) when the
  market is price sensitive (2) When production and
  distribution costs fall as sales volume
  increases, (3) when the low price keeps the
  competitors away.

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Product-Mix Pricing Strategies

• When the new products is part of product mix, the
  strategy for setting a products price often has
  be changed. Here, the firm looks for a set of
  prices that maximizes the profits for the total
  product mix.
• The product-mix pricing strategies are
• product line pricing
• optional-product pricing
• captive-product pricing
• by-product pricing
• product-bundle pricing

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Product Line Pricing

• Companies usually develop product lines rather
  than single products e.g. Nike, Kodak have
  serious of products in the same product category.
  In product-line pricing, the company must decide
  on the price steps to set between the various
  products in the line.
• The price steps should take into account (1)
  cost differences between the products, (2)
  customer evaluations of their different features,
  (3) competitors prices. Here, the marketers task
  is to establish perceived quality differences
  that support the price differences.

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Optional-Product Pricing

• Optional-product pricing offers to sell optional
  or accessory products along with their main
  product e.g. nowadays automobile companies like
  Ford offer a set of popular options such as air
  conditioning, power windows and door locks, and a
  rear window defroster at a package price.

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Captive-Product Pricing

• Captive-product pricing is setting a price for
  products that must be used along with a main
  product.
• Producers of the main products (e.g. computers,
  cameras...) often price them low but charge more
  for the supplies e.g. Polaroid prices its cameras
  low but camera films high where it makes its
  profit. Or Gilette sells low-prices razors but
  makes money on the replacement blades.

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• This strategy is called two-part pricing. The
  price of the service is broken down into a fixed
  fee plus a variable usage rate. E.g. a telephone
  company charges a monthly rate (the fixed fee)
  plus charges for extras (the variable usage
  rate). Amusement parks charge admission plus fees
  for food, attractions and rides over a minimum
  number. The fixed amount should be low enough to
  attract usage of the service profit is made on
  the variable fees.

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By-Product Pricing

• Setting a price for by-products in order to make
  the main products price more competitive.
• In by-product pricing, the manufacturer looks for
  a market that would buy the companys by-products
  and accepts the price that covers more than the
  cost of storage and delivery.

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Product-Bundle Pricing

• Combining several products and offering the
  bundle at a reduced price. E.g. season tickets of
  sports teams is cheaper than the cost of single
  tickets, hotels and agencies special priced
  packages, software packages of computer makers.
• This approach can promote the sales of products
  that consumers might not otherwise buy, but the
  combined price must be low enough to get them to
  buy the bundle.

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Price-Adjustment Strategies

• Companies adjust their prices according to the
  differences in customers and changing situations.
  There are several price adjustment strategies
• discount and allowance pricing
• segmented pricing
• psychological pricing
• promotional pricing
• geographic pricing
• international pricing

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Discount and Allowance Pricing

• Discount is a straight reduction in price on
  purchases during a stated period of time. There
  are different types of discounts
• cash discount is a price reduction to buyers who
  pay their bills promptly.
• quantity discount is a price reduction to buyers
  who purchase in large volume.
• functional discount (trade discount) is offered
  by the seller to trade channel members who
  perform certain functions like selling, storing,
  record keeping.
• seasonal discount is a price reduction to buyers
  who purchase merchandise or services out of
  season.

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• Allowances are another type of reduction from the
  list price.
• trade-in allowances are price reductions given
  for turning in an old item when buying a new one
  which is common in the automobile industry
• promotional allowances are payments or price
  reductions to reward dealers for participating in
  advertising and sales-support programs.

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Segmented Pricing

• Adjusting the basic prices to allow differences
  in customers, products, and locations. In this
  approach, the company sells a product or service
  at two or more prices. There are different
  segmented pricing forms
• in customer-segment pricing different customers
  pay different prices for the same product or
  service e.g. museums charge students and senior
  citizens lower.

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• in product-form pricing different versions of
  the product are priced differently but not
  according to differences in their costs e.g. the
  most favorite or top model of the product line
  may have higher price.
• in location pricing a company charges different
  prices for different locations, even though the
  cost of offering each location is the same e.g.
  theatres vary their seat prices, universities
  charge higher tuition for out-of-state students
• in time pricing a firm varies its price by the
  season, the month, the day, and even the hour
  e.g. telephone companies offer lower off-peak
  charges, resorts give seasonal discounts.

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Psychological Pricing

• Price says something about the product,
  especially about its quality.
• in psychological pricing sellers consider the
  psychology of prices rather than economics.
• E.g. Heublein priced its new vodka brand high
  against Smirnoff which gave the customers the
  impression that Heublein is better than Smirnoff,
  therefore, the sales grow rapidly.
• The difference between 300 and 299.95 is just
  five cents but the psychological difference can
  be much greater. Some consumers will see the
  299.95 as a price in the 200 range rather than
  the 300 range.

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Promotional Pricing

• Temporarily pricing products below list price,
  and sometimes even below cost, to increase
  short-run sales. There are several forms
• loss leaders supermarkets generally price a few
  items as loss leaders to attract customers to the
  store in the hope that they will buy other items
  at normal markups.

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• special-event pricing products are priced low in
  certain seasons to draw more customers.
• cash rebates are offered to customers who buy
  the product from dealers within a specified time.
  Rebates would be offered as low-interest
  financing, longer warranties, or free maintenance
  to reduce the consumers price.
• discounts would be offered to reduce the price
  for the customer.

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Geographic Pricing

• Deciding how to price products for customers
  located in different parts of the country or
  world. Here, the company must decide whether to
  charge the distant customers higher to cover its
  shipping costs.
• in FOB-origin pricing (free-on-board) the
  customer is responsible to pay for the shipping.
• in uniform delivery pricing the company charges
  the same price plus the average shipping cost,
  regardless of the customers location.

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• in zone pricing the company sets up two or more
  zones. All customers within a given zone pay a
  single total price the more distant the zone,
  the higher the price.
• in basing-point pricing the seller selects a
  given city as a basing point and charges all
  customers the shipping cost from that city to the
  customer location.
• in freight(cargo)-absorption pricing the seller
  absorbs (covers) all or part of the actual
  freight (shipping) charges to get some desired
  customers.

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International Pricing

• Companies that market their products
  internationally must decide what prices to charge
  in different countries.
• The company either set a uniform price or adjust
  their prices to reflect local market conditions.
• Factors that influence price adjustment would be
• economic conditions
• competitive situations
• laws and regulations

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• costs e.g. a pair of Levis is sold for 30 in the
  US, but 63 in Tokyo and 88 in Paris. Or
  McDonalds Big Mac is 2.25 in the US but 5.75
  in Moscow.
• Selling strategies and market conditions e.g. a
  Gucci handbag is 60 in Milan but 240 in the US.