MARKETING MIX (PRICE) Learning objectives After reading this chapter, you should be able to; 1. Understand what is price? 2. Explain all the Pricing strategies 3. Explain how price affects demand and how demand affects price 4. Explain the Pricing objectives 5. Explain What is price discrimination 6. Discuss the importance of price in marketing. 7. Identify and define the internal and external factors affecting pricing decisions. 8. Contrast general approaches to setting prices 9. Describe pricing strategies for imitative and new products and know when to use them. 10. Explain how pricing is influenced by the product mix and show how companies determine a set of prices that maximizes the profits of the total product mix 11. Discuss how companies adapt prices to meet different market circumstances and opportunities. 12. Discuss the key issues relating to initiating and responding to price changes. MARKETING MIX (PRICE) WHAT IS PRICE? Price is the amount of money charged for a product or service, or the sum of the values that consumers exchange for the benefits of having or using the product or service. ( Philip Kotler- principles of marketing – 4th European Edition). Price is the monetary value of a good or service. MARKETING MIX (PRICE) Factors to consider when setting prices: factors affecting pricing decisions. External factors: Internal Factors: •Nature of the market and •Marketing objectives Demand •Marketing mix strategy Pricing decisions •Competition •Production Costs •Other environmental factors •Organisational considerations (economy, resellers, Government/regulators PRIMARY CONSIDERATIONS IN PRICE SETTINGS High price Low price No possible Competitors’ prices and Consumer product No possible Profit at this cost other external and internal factors Perceptions demand at price of value this stage PRICE AND DEMAND Price influences the demand for goods and services. Generally, the higher the price the lower the demand and the lower the price the higher the demand. But there are exception to this rule. Some ostentatious products or (speciality products) may show a different pattern which is when price increase demand may instead increase. Price influences the quantity of goods demanded. Price influences the level of profit made by businesses. Price determines the quality and value. Price also varies from one market to the other and from one geographical region to another. A product priced in UK for £10 may be priced differently in other countries say France, Ghana, USA etc because of differences in demand, value of currency and different economic situation. Production costs influences prices. The higher the cost of producing a product, the higher the prices and the lower the production cost, the lower the prices. PRICE AND DEMAND PRICING STRATEGIES General pricing approaches – pricing strategies 1. Cost-based pricing Cost-plus pricing Mark-up/Mark-down pricing Break-even pricing/target profit pricing 2. Value based pricing 3. Competition-based pricing Going rate pricing Sealed-bid pricing New Product pricing strategies: 4. Market-skimming pricing 5. Market-penetration pricing Product mix pricing strategies 6. Product line pricing 7. Optional-product pricing 8. Captive-product pricing 9. By-product pricing 10. Product-bundle pricing Price adjustment strategies 11. Discount and allowance pricing 12. Segmented pricing: customer segment pricing, product-form pricing, location pricing & time pricing. 13. Psychological pricing: reference prices 14. Promotional pricing: cash discount, quantity discount, quantity premium, functional discount (trade discount), seasonal discount, trade-in allowance & promotional allowance) 15. Geographical pricing: FOB – Origin pricing, Uniform delivered pricing, Zero pricing, Basing-point pricing & Freight-absorption pricing. 16. International pricing Other pricing strategies 17 Demand based pricing 18 Market based pricing PRICING STRATEGIES Cost-based versus value-based pricing Cost-based pricing Product Cost Price Value Customers Value-based pricing Customers Value Price Cost Product PRICING STRATEGIES Competition based pricing Setting the price based upon prices of the similar competitor products. Competitive Pricing is based on three types of competitive product: 1) Products have lasting distinctiveness from competitor's product. here we can assume a) The product has low price elasticity. b) The product has low cross elasticity. c) The demand of the product will rise. 2) Products have perishable distinctiveness from competitor's product, assuming the product features are medium distinctiveness. 3) Products have little distinctiveness from competitor's product. assuming that: a) The product has high price elasticity. b) The product has some cross elasticity. c) No expectation that demand of the product will rise. The pricing is done based on these three factors. PRICING STRATEGIES Cost-plus pricing is the simplest pricing method. The firm calculates the cost of Cost-plus pricing producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws; it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price. Price = Cost of Production + Margin of Profit. Price skimming Selling a product at a high price, sacrificing high sales to gain a high profit, therefore ‘skimming’ the market. Usually employed to reimburse the cost of investment of the original research into the product - commonly used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a high price. This strategy is often used to target "early adopters" of a product/service. These early adopters are relatively less price sensitive because either their need for the product is more than others or they understand the value of the product better than others. This strategy is employed only for a limited duration to recover most of investment made to build the product. To gain further market share, a seller must use other pricing tactics such as economy or penetration. In price skimming, price varies over time. Typically a company starts selling a new product at a relatively high price then gradually reduces the price as the low price elasticity segment gets satiated. Price skimming is closely related to the concept of yield management. PRICING STRATEGIES Limit pricing This is a strategy of pricing adopted by firms in a contestable market in order to 'limit' the ability of new entrants to take advantage of economies of scale where by costs are Low enough for them to become competitive. Market oriented pricing Setting a price based upon analysis and research compiled from the targeted market. Price discrimination exists when sales of identical goods or services are transacted at different prices from the same provider. In a theoretical market with perfect information, no transaction costs and a prohibition on secondary exchange (or re-selling) to prevent arbitrage, price discrimination can only be a feature of monopoly markets. Otherwise, the moment the seller tries to sell the same good at different prices, the buyer at the lower price can arbitrage by selling to the consumer buying at the higher price but with a tiny discount. However, market frictions in oligopolies such as the airlines, and even in fully competitive retail or industrial markets allows for a limited degree of differential pricing to different consumers. Price discrimination also occurs when it costs more to supply one customer than it does another, and yet the supplier charges both the same price. Although the term "discrimination" has negative connotations, "price discrimination" is merely a technical term meaning differentiation in price to increase efficiency. PRICING STRATEGIES However, the effects of price discrimination on social efficiency are unclear. Typically such behaviour leads to lower prices for some consumers and higher prices for others. Output can be expanded as when price discrimination is very efficient, but output can also decline when discrimination is more effective at extracting surplus from high-valued users than expanding sales to low valued users. Even if output remains constant, price discrimination can reduce efficiency by misallocating output among consumers. Price discrimination requires market segmentation and some means to discourage discount customers from becoming resellers and, by extension, competitors. This usually entails using one or more means of preventing any resale, keeping the different price groups separate, making price comparisons difficult, or restricting pricing information. The boundary set up by the marketer to keep segments separate are referred to as a rate fence. Price discrimination is thus very common in services, where resale is not possible; an example is student discounts at museums. In price discrimination, price may vary according to customer, location, quantity, quality, and according to segment Four price-positioning strategies Price High Low High Good-value Premium strategy strategy Quality Low Overcharging strategy Economy strategy PRODUCT-MIX PRICING STRATEGIES Product line Optional product Captive product By-product Product-bundle pricing pricing pricing pricing pricing Setting price Pricing optional Pricing products Pricing low-value Or accessory That must be used Steps between By-products to Pricing bundles Products With the main Of products Product line items Get rid of them sold with products Sold together The main product Price adjustment strategies Discount and Segmented Psychological Value pricing Promotional Geographical International Allowance pricing pricing pricing pricing pricing pricing Reducing Adjusting Adjusting Temporarily Adjusting Adjusting Adjusting Prices to Reducing Prices to Prices to prices Prices Prices Offer the Prices to Account Reward To allow for in for Right Increase For the Customers differences Internatio- Psychological combination short-run Geographical Responses In customers, nal effect Of quality sales Location of Such as Products and markets Paying locations And service customers Early or At a fair price Promoting The product Elasticity of demand Price elasticity of demand the price elasticity of demand (PED) is an elasticity that measures the nature and degree of the relationship between changes in quantity demanded of a good and changes in its price. Price elasticity of demand is measured as the percentage change in quantity demanded that occurs in response to a percentage change in price. For example, if,in response to a 10 % fall in the price of a good, the quantity demanded increases by 20 %, the price elasticity of demand would be 20 %/(− 10 %) = −2 In general, a fall in the price of a good is expected to increase the quantity demanded, so the price elasticity of demand is negative as above. Note that in economics literature the minus sign is often omitted and the elasticity is given as an absolute value. (Case & Fair, 1999: 110). Because both the denominator and numerator of the fraction are percent changes, price elasticities of demand are dimensionless numbers and can be compared even if the original calculations were performed using different currencies or goods. An example of a good with a highly inelastic demand curve is salt: people need salt, so for even relatively large changes in the price of salt, the amount demanded will not be significantly altered. Similarly, a product with a highly elastic demand curve is red cars: if the price of red cars went up even a small amount, demand is likely to go down since substitutes are readily available for purchase (cars of other colors). Price elasticity of demand It may be possible that quantity demanded for a good rises as its price rises, even under conventional economic assumptions of consumer rationality. Two such classes of goods are known as Giffen goods or Veblen goods. Another case is the price inflation during an economic bubble. Various research methods are used to calculate price elasticity: Test markets Analysis of historical sales data Conjoint analysis The formula used to calculate the coefficient of price elasticity of demand is Using all the differential calculus: where: P = price Q = quantity Types of elasticity of demand Fairly elastic demand (ED >1) Fairly inelastic demand (ED<1) Perfectly elastic demand (ED = Infinity) Perfectly inelastic demand (ED = 0) Unitary elasticity of demand (ED = 1) See also Supply and demand Price elasticity of demand Price elasticity of supply Income elasticity of demand Cross elasticity of demand Arc elasticity Perfectly elastic demand Perfectly inelastic demand PRICE CHANGES After developing their price structures and strategies, companies often face situations in which they must initiate price changes or respond to price changes by competitors. INITIATIING PRICE CHANGES Initiating price cuts Initiating price increases Buyer reactions to price changes Competitor reactions to price changes RESPONDING TO PRICE CHANGES Here we reverse the question and ask how a firm should respond to a price change by a Competitor. The firm needs to consider several questions: Why did the competitor change the price? Was it to make more market share, to use excess capacity, to meet changing cost conditions or to lead an industry-wide price changes? Is the price change temporary or permanent? What will happen to the company’s market share and profits if it does not respond? Are other companies going to respond? What are the competitor’s and other firms’ responses to each possible reaction likely to be? RESPONDING TO PRICE CHANGES If the company decides that effective action can and should be taken, it might make any of the following four responses. 1. Reduce price 2. Raise perceived value 3. Improve quality and increase price. 4. Launch low-price ‘fighting brand’. KEY Terms and definitions Dynamic pricing: Charging different prices depending on individual customers and situations: Dynamic pricing can be likened to price discrimination: Target costing - A technique to support pricing decisions, which starts with deciding a target cost for a new product and works back to designing the product. Fixed costs - Costs that do not vary with production or sales level. These are costs that remain fixed as output increases or decreases in the short run. Variable costs-costs that vary directly with the level of production – cost that changes as output increases or decreases in the short run Total costs - the sum of the fixed and variable costs for any given level of production. Experience curve (learning curve): The drop in the average per-unit production cost that comes with accumulated production experience. Pure competition: a market in which buyers and sellers trade in a uniform commodity- no single buyer or seller has much effect on the going market price. Monopolistic competition- A market in which many buyers and sellers trade over a range of prices rather than a single market price. Oligopolistic competition- A market in which there are a few sellers that are highly sensitive to each other’s pricing and marketing strategies. Pure monopoly – a market in which there is a single seller- it may be a government monopoly, a private regulated monopoly or a private non-regulated monopoly. PRICE ELASTICITY- A measure of the sensitivity of demand to changes in price. Net profit- the difference between the income from goods sold and all expenses incurred. MARKETING MIX (PRICE) KEY Terms and definitions Cost-plus pricing- Adding a standard mark-up to the cost of the product. Mark-up/mark-down – the difference between selling price and cost as a percentage of selling price or cost. Break-even pricing (target profit pricing): Setting price to break even on the costs of making and marketing a product; or setting a price to make a target profit. The break even price is when the price set is equal to the production cost. Break-even volume = Fixed cost Price-Variable cost Value-based pricing- setting price based on buyers’ perceptions of product values rather than cost. Value pricing- offering just the right combination of quality and good service at a fair price. Going-rate pricing/competitor based pricing- setting price based largely on following competitors’ prices rather than on company costs or demand. First price sealed-bid pricing- potential buyers submit sealed bids, and the item is awarded to the buyer who offers the best price. --- (common during auctions) English auction- price is raised successively until only one bidder remains Dutch auction- prices start high and lowered successively until someone buys. Collective buying- an increasing number of customers agree to buy as prices are lowered to the final bargain price. Reverse auction- customers name the price that they are willing to pay for an item and seek a company willing to sell. KEY Terms and definitions Second-price sealed bid- Sealed bids are submitted but the contender placing the best bid pays only the price equal to the second best bid. Strapline – a slogan often used in conjunction with a brand’s name, advertising and other promotions. Market-skimming pricing- setting a high price for a new product to skim maximum revenues layer by layer from the segments willing to pay the high price; the company makes fewer but more profitable sales. Market penetration pricing- Setting a low price for a new product in order to attract large numbers of buyers and a large market share. Product line pricing- setting the price steps between various products in a product line based on cost differences between the products, customer evaluations of different features, and competitors’ prices. Optional-product pricing- the pricing of optional or accessory products along with a main product. Captive-product pricing- setting a price for products that must be used along with a main product, such as blades for a razor and film for a camera. Two-part pricing- a strategy for pricing services in which price is broken into a fixed fee plus a variable usage rate. By-products- items produced as a result of the main factory process, such as waste and reject items. By-product pricing- setting a price for by-products in order to make the main product’s price more competitive. KEY Terms and definitions Product-bundle pricing- combining several products and offering the bundle at a reduced price. Cash discount- a price reduction to buyers who pay their bills promptly. Quantity discount- a price reduction to buyers who buy large volumes. Quantity premium- A surcharge paid by buyers who purchase high volumes of a product. Functional discount (trade discount)- a price reduction offered by the seller to trade channel members that perform certain functions, such as selling, storing and record keeping. Seasonal discount- a price reduction to buyers who buy merchandise or services out of season. Trade-in allowance- a price reduction given for turning in an old item when buying a new one. Promotional allowance- a payment or price reduction to reward dealers for participating in advertising and sales support programmes. Segmenting pricing- pricing that allows for differences in customers, products and locations. The differences in prices are not based on differences in costs. Psychological pricing- a pricing approach that considers the psychology of prices and not simply the economics; the price is used to say something about the product. Reference prices- prices that buyers carry in their minds and refer to when they look at a given product. Key terms and definition Promotional pricing- temporarily pricing products below the list price, and sometimes even below cost, to increase short-run sales. Geographical pricing- pricing based on where customers are located FOB – ORIGIN PRICING- A geographical pricing strategy in which goods are placed free on board a carrier; the customer pays the freight from the factory to the destination. Uniform delivered pricing- a geographic pricing strategy in which the company charges the same price plus freight to all customers, regardless of their location. Zero pricing – a geographic pricing strategy in which the company sets up two or more zones. All customers within a zone pay the same total price; the more distant the zone, the higher the price. Basing-point pricing – a geographical pricing strategy in which the seller designates some city as a basing point and charges all customers the freight cost from that city to the customer location, regardless of the city from which the goods are actually shipped. Freight-absorption pricing- a geographic pricing strategy in which the company absorbs all or part of the actual freight charges in order to get the business. Questions for revision: 1. Examine the internal and external factors businesses should take into consideration before setting the price for their products? 2. List and discuss four pricing strategies used by businesses. 3. Explain how price can influence the demand for products and how the demand can influence the price of products.
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