12 Pricing Concepts and Strategies

Document Sample
12 Pricing Concepts and Strategies Powered By Docstoc

                      Chapter 12: Pricing Concepts and Strategies: Establishing Value
Price: the overall sacrifice a consumer is willing to make- money, time, energy- to acquire a specific
product or service. (travel costs, taxes, shipping costs, time to acquire etc)
    - Also used as a cue to judge the service/product’s quality

To gain overall value: consumers judge benefits the product delivers against the sacrifice necessary to
obtain it. (over priced good product may have less value then well priced inferior product)
    - Relationship between price and the benefits received

Key To Pricing: match the product or service with the consumer’s value perceptions. Consumers want
something that is high VALUE
   - Price too high: won’t buy too expensive
   - Price too low: signal low quality, poor performance etc

The 5 Cs of Pricing
   - Customers                               - costs
   - Competition                              - channel members
   - Company objectives

    -   Companies set prices based on the following:
    1.  Company Objectives
    -   Objectives based on what management believes is necessary for success
    -   Based on how the firm plans to grow (increasing sales, profits, decreasing competition,
        customer satisfaction etc)
    - Ex. Wal Mart – value based company, Holts- high end
Company objectives and strategies include: (do not have to be mutually exclusive, just can’t contradict)
Profit Orientation
            o A company objective that can be implemented by focusing on target profit pricing,
                maximizing profits, or target return pricing
                     Target Profit Pricing: a pricing strategy implemented by firms when they have
                        particular profit goal as their overriding concern; uses price to stimulate a
                        certain level of sales at a certain profit per unit
                             Have a particular profit target that they want to reach
                     Maximizing Profits Strategy: mathematical model that captures all the factors
                        required to explain and predict sales and profits, which should be able to
                        identify the price at which its profits are maximized
                             Which price will produce the max amount of profits
                     Target Return Pricing: firms less concerned with the absolute level of profits
                        and more interested in the rate at which their profits are generated relative to
                        their investments
                             Designed to produce a specific return on investment, usually a
                                 percentage of sales
    - Strategy example: all products must provide a 18% profit margin

Sales Orientation
    - Company objective based on the belief that increasing sales will help the firm more than will
        increasing profits
    - set prices trying to increase sales

   -   for sales to increase, consumers must see greater value
   -   goal to gain overall market share
   -   doesn’t have to be low price, just offer a high quality product at a fair price
   -   Strategy includes: set prices low to generate new sales, take sales away from competitors, even
       if profits suffer

Competitor Orientation
   - A company objective based on the premise that the firm should measure itself primarily against
      its competition
   - Competitive Parity: firm’s strategy of setting prices that are similar to major competitors
   - Value is only considered if competitors are considering value and you copy them
   - Strategy: to discourage competitors from entering, price products very low

Customer Orientation
   - Pricing orientation that explicitly invokes the concept of customer value and setting prices to
      match consumer expectations
   - Focus on increasing customer satisfaction
   - Strategy example: target a market segment who highly value a particular product benefit and
      set prices relatively high
          o No haggle price policy
          o High priced, state of the art policy, increase company image and reputation

   -   After a company has its objectives, it should implement strategies that enable it to achieve
       those objectives

    2. Customers
    - Customers reactions to different prices
Demand Curve
    - How many units will consumers demand at a specific price
    - Demand increases as price decreases (inverse relationship), ceteris paribus
    - Because of greater value lower price point offers
    - Prestige products or services: those that customers purchase for stats rather than functionality
             o The higher the price, the greater the status, greater exclusivity
             o Demand increases as price increases (up to a certain point)
Price Elasticity of Demand
    - We need to see how sensitive the product is to price change to know how much marketers can
         change the price
    - Price elasticity of demand: measures how changes in a price affect the quantity of the product
         demanded; specifically the ratio of the percentage change in quantity demanded to the
         percentage change in price
             o Price elasticity of demand= %change in quantity demanded/%change in price
    - Elastic:
             o A market for a product or service that is price sensitive
             o Relatively small changes in price will generate large changes in the quantity demanded
             o Changes in quantity are greater than changes in price
             o Price elasticity is greater than 1
    - Inelastic:
             o Market for a product or service that is price insensitive

            o   Relatively small changes in price will not generate large changes in the quantity
            o Price elasticity is less than 1
            o Changes in price are greater than changes in quantity
            o Easier to raise prices, as consumers will still buy the product
    -   Factors Influencing Price Elasticity of Demand
            o Income Effect
                      The change in the quantity demanded by consumers due to the change in their
                      Income increases, demand shifts to higher priced alternatives
            o Substitution Effect
                      Consumers’ ability to substitute other products for the focal brand
                      thus more substitution leads to increasing the price elasticity of demand for the
                        focal brand
                      if many close substitutes, very easy to change brands if prices increase
            o Cross Price Elasticity
                      The percentage change in demand for product A that occurs in response to a
                        percentage change in price of product B
                      Complementary Products: products whose demand curves are positively
                        related, such that they rise or fall together. A percentage increase in demand for
                        one results in percentage increase in the demand for the other
                             Ex dvds and dvd players
                      Substitute Products: products for which changes in demand are negatively
                        related; that is a percentage increase in the quantity demanded for product A
                        results in a percentage decrease in the quantity demanded for product B
                             Ex. dvd players and vcrs

    3. Costs
    - Must understand their cost structures so that they can determine the degree to which their
       products/services will be profitable at different prices
    - Prices should not be based on costs, because the consumer really does not care how much it
       takes the company to produce, just cares about the values and benefits it provides them
    - 2 main types of costs:
           o Variable Costs: those costs, usually labour and materials, that vary with production
           o Fixed Costs: those costs that remain the same level, regardless of any changes in the
               volume of production
           o Total Costs: variable costs +fixed costs = variable cost/unit*units + fixed costs

Break Even Analysis
Break Even point: the point at which number of units sold makes revenue= total costs. Profits = 0
Contribution per unit: = sales price – variable costs per unit

Break even point (units) = Fixed Costsdddddddd
                         Contribution per unit

   -   Doesn’t help to set prices, but helps to assess the pricing strategies because shows when the
       product becomes profitable , also helps to compare different pricing options

   4. Competition
   - Effect of competitors and how they react to certain pricing strategies
   - Oligopolistic Competition
         o Occurs when only a few firms dominate a market
         o Firms change their prices in reaction to competition to avoid upsetting the stable
              competitive environment
         o Ex banking and gas industry
         o Can result in a price war (occurs when 2 or more firms compete primarily by lowering
              their prices, however better service, quality and brand loyalty may help)
   - Monopolistic Competition
         o Occurs when there are many firms that sell closely related but not homogeneous
              products, they are differentiated; these products may be viewed as substitutes but are
              not perfect substitutes
         o Product differentiation appeals more to customers
   - Pure Competition
         o Occurs when different companies sell commodity products that consumers perceive as
              substitutable; price usually is set according to the laws of supply and demand
         o Try to differentiate it somehow as price wars will erode profits

   5. Channel Members
   - Manufacturers, wholesalers, retailers all have different perspectives when it comes to pricing
   - Ex. manufacturer may want to emphasize quality and have increased price but retailer may
      want to increase sales and have cheaper price
   - Channel members must carefully communicate pricing goals with each other and select channel
      partners that agree with them
   - Grey market: employs irregular but not necessarily illegal methods; generally it legally
      circumvents authorized channels of distribution to sell goods at prices lower than those
      intended by the manufacturer

Other Influences on Pricing

The Internet
   - Internet has increased the price sensitivity of products by:
           o Online shopping has made products more price sensitive and opened up new categories
             of products to those who could not access them previously
           o Because things are available on the internet, consumers demand more from other
             retailers in terms of selection and variety and have become more sensitive to prices
           o internet allows people to purchase products cheaper, physical stores must show
             benefits of shopping there
           o allows consumers to find best prices for any product quickly
           o Consumers know more about the products, companies, competitors, and the market
           o More online auction sites (Ebay)- does self-appraisal of products as people bid to
             determine value of products

Economic Factors
   1. Increase in Consumers’ disposable income and Increase in status consciousness
          o More customers have more disposable income and are able to afford the very elite
   2. At the same time, consumers want to shop cheap sometimes

These contradictory trends have lead to prestige items becoming more expensive and other items
becoming cheaper
Cross shopping: the pattern of buying both premium and low priced merchandise or patronizing both
expensive, status oriented retailers and price oriented retailers

    3. Economic Environment at local, regional, national, and global level influences pricing
    - Global: the whole production process is global, can have most cost efficient way to supply to
    - Local: prices based on competition, disposable income, and unemployment in area of selling

    - Coming up with the right price is based on the situation: product, market condition
    - Pricing strategy is specific to the product/service and target market
    - Strategies for pricing include:
Cost Based Method
    - Determines the final price to charge by starting with the cost, without recognizing the role that
       consumers or competitors’ prices play in the marketplace
    - All costs must be identified on a per unit basis
    - Must use average costs, as cost varies with production level
    - Method that decides price based on what it costs to produce the product

Competitor Based Method
   - An approach that attempts to reflect how the firm wants consumers to interpret its products
      relative to the competitors’ offerings
   - Set price based on competitor’s pricing and how it was to be seen in the market
   - Ex. setting price close shows that it is very similar, setting price much higher signals more quality

    -   Premium pricing: a competitor based pricing method by which the firm deliberately prices a
        product above the prices set for competing products to capture those consumers who always
        shop for the best or for whom price does not matter

Value- Based Pricing Method
    - Focuses on the overall value of the product offering as perceived by consumers
    - who determine value by comparing the benefits they expect the product to deliver with the
        sacrifice they will need to make to acquire the product
    - 2 approaches to value based pricing methods:
            o Improvement Value Method
                      Represents an estimate of how much more or less consumers are willing to pay
                         for a product relative to other comparable products
                      Provides an estimate of how much better the product is than others

                      Improvement measure is calculated using incremental benefits, weighting the
                       benefits, and finding the weighted factor
           o   Cost of Ownership Method
                   A value based method for setting prices that determines the total cost of
                       owning the product over its useful life
                   With this, consumers may be willing to pay more for a product because over its
                       entire lifetime, the product will cost less to own than a cheaper alternative
                       (have to buy multiple of the cheaper alternatives)

New Product Pricing
   - If pricing a new product that is similar to old ones: product’s approximate value is already
      established in the market
   - If pricing a product that is new to the world: must determine consumers’ perceptions and value,
      harder to price
   - 2 pricing strategies for new products are:

   1. Price Skimming- set prices high
   - Strategy for selling new products/services at a high price that innovators and early adoptors are
      willing to pay in order to obtain it
   - After the high price market segment becomes saturated and sales being to slow down, the firm
      generally lowers the price to capture (or skim) the next most price sensitive segment
   - Start off with a really high price and then slowly starting to decrease price to attract the next
      group of consumers
   - Profits through margin
   - For price skimming to work:
           o Product must be perceived as a breakthrough, offering more benefits that are currently
               unavailable in alternative products
           o Competitors cannot easily enter the market- or else price competition will force lower
               prices to undermine the whole strategy (protect from competition through patents,
               inability to copy the product, or high costs of entry)
   - Firms use Price Skimming because:
           o Price really high to signal quality to the market
           o Price high to limit demand, giving time to increase production capabilities
           o Quickly earn back some of the money lost in research and development
           o Test consumers’ price sensitivity (firm setting price too high can always lower the price,
               but to raise the price will be met with resistance)
   - Drawbacks of Skimming strategies:
           o Relatively high unit costs when producing small volumes of product
           o Unhappy consumers- those who purchase the product early at a higher price may be
               unhappy when the prices drop

   2. Market Penetration Pricing –set prices low
   - A pricing strategy of setting the initial price low for the introduction of the new product or
      service, with the objective of building sales, market share, and profits quickly
   - Setting price low to encourage customers to buy immediately than waiting for price to drop
   - Profits through volume
   - Experience Curve Effect: as the volume sold increases, the unit cost is expected to drop. As sales
      grow, the costs continue to drop allowing even further reductions in price

    -   Pros:
            o   Potential to quickly build sales, market share, and profits
            o   Discourages competitors from entering the market because the profit margin is
                relatively low
    -   Cons:
           o Firm must have capacity to deal with the quick rising demand
           o Low prices do not signal high quality
           o Firms should avoid penetration pricing if some segments of market are willing to pay
              more for the product, basically throwing away money

Psychological Factors Affecting Value-Based Pricing Strategies
    - psychology of how consumers arrive at their perceptions, judgements, and invoke choice,
       consumers reactions to and use of price, factors of how consumers evaluate price

     1. Consumers’ Use of Reference Prices
Reference Price: the price against which buyers compare the actual selling price of the product and that
facilitates their evaluation process

External Reference Price: a higher price to which the consumer can compare the selling price to
evaluate the purchase.
            o The seller itself can provide this. Seller lables the external price as the “regular price”
            o Consumer looks at “sale” price and perceptions of value will increase

Internal Reference Price: price information stored in the consumer’s memory that the person uses to
assess a current price offering- perhaps the last price he or she paid or what she expects to pay

    2. Everyday Low Pricing (EDLP) versus High/Low Pricing
Everyday Low pricing (EDLP): a strategy companies use to emphasize the continuity of their retail prices
at a level somewhere between the regular, non sale price and the deep discount sales price that
competitors may offer. Offering a price that is lower than normal price of competitors
    - Reduces customer search costs, presented right there, consumers don’t have to look
    - On average, prices are lower overall. ....WAL MART
    - Perception that it has lower quality goods

High- Low Pricing: a pricing strategy that relies on the promotion of sales, during which prices are
temporarily reduced to encourage purchases
    - Have sales to encourage purchases on the temporarily reduced price
    - Consumers can enjoy the adventure of looking for the best sale
    - Perception of higher quality goods

    3. Odd Prices
    - Prices that end in odd numbers...usually 9
    - Consumers mentally believe that the price is lower than it actually is

    4. The Price-Quality Relationship
    - Belief that a higher price means higher quality

Pricing Tactics
Pricing Strategy: long term approach to setting prices across all of the firm’s products based on the 5 Cs
Pricing Tactics: offer short term methods to focus on select components of the 5 Cs. A short term
response to a competitive threat, or broadly accepted method that is short term in nature

Business to Business (B2B) Pricing Tactics and Discounts
Seasonal Discounts
             o Pricing tactic offering an additional reduction as an incentive to retailers to order
                 merchandise in advance of the normal buying season
             o Discounts for purchasing before they usually would, before it gets busy
Cash Discounts
             o Offering a reduction in the invoice cost if the buyer pays the invoice prior to the end of
                 the discount period
             o 3/10,n30....getting money earlier, time value of money
     - Lowers the final cost to channel members in return for specific behaviours
Advertising Allowance: offering a price reduction to channel members if they agree to feature the
manufacturer’s product in their advertising and promotional efforts
Listing Allowance: fees paid to retailers simply to get new products into stores or to gain more or better
shelf space for their products

Quantity Discount
           o Offering a reduced price according to the amount purchased
           o The more the buyer purchases, the higher the discount, and the greater the value
                   Cumulative Quantity Discount: offers a discount based on the amount
                     purchased over a specified period and usually involve several transactions. This
                     forms a relationship as they are earning the discount over time
                   Noncumulative Quantity Discount: discount based only on amount purchased in
                     a single order. Incentive to purchase more immediately

Uniform Delivered versus Geographic Pricing
    - Uniform delivered pricing: the shipper charges one rate, no matter where the buyer is located
    - Geographic Pricing: the setting of different prices depending on a geographical division if the
       delivery areas

Pricing Tactics Aimed at Consumers
    1. Price Lining
    - Consumer market pricing tactic of establishing a price floor and a price ceiling for an entire line
        of similar products and then setting a few other price points in between to represent distinct
        differences in quality
    - Having different price points to satisfy all tastes and needs and budgets
    - Having different levels of prices

    2. Price Bundling
    - Consumer pricing tactic of selling more than one product for a single, lower price than what the
       items would cost sold separately
           o Can be used to sell slow moving items
           o Encourage customers to stock up so they don’t use competing brands

           o   To encourage trial of a new product
           o   To provide an incentive to purchase a less desirable product or service to obtain a more
               desirable one in the same bundle
           o   Ex. BELL

   3. Leader Pricing
   - Consumer pricing tactic that attempts to build store traffic by aggressively pricing and
      advertising a regularly purchased item, often priced at or just above the store’s cost
   - a deal on one product to get people into the store and then they will buy it and other products
      as well
   - ex. grocery stores, corn on sale

Consumer Price Reductions
   - final price a customer pays for a product has been adjusted from original price to enhance value
   - techniques include:
          o Markdowns:
                    Reductions retailers take on the initial selling price of the product/service
                    Retailers can get rid of slow moving, obsolete merchandise
                    Sell seasonal, match competitor’s prices
                    Must get rid of bad inventory because it is expensive and hurts image
                    Promote merchandise, increase sales
                    Increase traffic into the store
          o Quantity Discounts for Consumers
                    Size discount: quantity discount at the consumer level. The larger the quantity
                       bought, the less the cost per unit
                    Ex. buying family sized package of cheerios
                    Consumers will buy bigger package/more every time they come, therefore less
                       likely to switch brands, consume more of the product
          o Seasonal Discounts
                    Price reductions offered on products and services to stimulate demand during
                       off peak seasons
                    Hotel rooms, bbq grills, bathing suits etc
          o Coupons and Rebates
                    Discount to consumer off final price
                    Coupon: provides a stated discount to consumers on the final selling price of a
                       product, retailer handles the discount
                    Rebate: discount in which a portion of the purchase price is returned to buyer in
                       cash, manufacturer issues the refund
                    Goals: prompt to buy product, reward loyal customers, encourage repurchases

Legal Aspects and Ethics of Pricing
   - Unfair practices that can unfairly reduce competition, harm consumers
   - Unfair practices include:

    1. Deceptive or Illegal Price Advertising
   - Advertising a specific claim that is a lie and may harm consumers
         o Deceptive Reference Prices
                  Lying about external reference prices
         o Loss Leader Pricing
                  Takes tactic of leader pricing one step further and lowering the price below the
                       store’s cost
                  Usually leader pricing is decreasing price, but still above the store’s cost,
                       however loss leader is decreasing below the store’s cost
         o Bait and Switch
                  Luring customers into the store with a very low advertised price on an item (the
                       bait), only to aggressively pressure them into purchasing a higher priced item
                       (the switch)
                  By insulting the lower priced item, comparing unfavourably, or supplying
                       inadequate amount

    2. Predatory Pricing
   - A firm’s practice of setting a very low price for one or more of its products with the intent to
       drive its competition out of business
   - Illegal under the competition act
       To prove: must show intent and that prices are lower than average costs

    3. Price Discrimination
   - Practice of selling the same product to different consumers at different prices, some forms of
       price discrimination are illegal
   - However, quantity discounts, agreements, etc make this hard to prove

    4. Price Fixing
   - The practice of colluding with other firms to control prices
          o Horizontal Price Fixing
                    Competitors that produce and sell competing products collude to control prices
                    Taking price out of the decision process for consumers
          o Vertical Price Fixing
                    Parties at different levels of the same marketing channel (manufacturers,
                      retailers) collude to control the prices passed on to consumers

Shared By: