1. CHAPTER 18 Setting the Right Price Designed by Eric Brengle B-books, Ltd. Prepared by Deborah Baker Texas Christian University Introduction to Marketing McDaniel, Lamb, Hair 9
2. Learning Outcomes Describe the procedure for setting the right price Identify the legal and ethical constraints on pricing decisions Explain how discounts, geographic pricing, and other special pricing tactics can be used to fine-tune the base price LO I LO 2 LO 3
3. Learning Outcomes Discuss product line pricing Describe the role of pricing during periods of inflation and recession LO 5 LO 4
4. How to Set a Price on a Product or Service Describe the procedure for setting the right price LO I
5. How to Set a Price on a Product or Service LO I Fine tune with pricing tactics Choose a price strategy Estimate demand, costs, and profits Establish pricing goals Results lead to the right price
7. Choose a Price Strategy A basic, long-term pricing framework, which establishes the initial price for a product and the intended direction for price movements over the product life cycle . LO I Price Strategy
8. Choose a Price Strategy LO I Status Quo Pricing Price Skimming Penetration Pricing Charging a price identical to or very close to the competition’s price. A firm charges a high introductory price, often coupled with heavy promotion. A firm charges a relatively low price for a product initially as a way to reach the mass market.
9. Price Skimming LO I Situations When Price Skimming Is Successful Unique Advantages/Superior Legal Protection of Product Blocked Entry to Competitors Technological Breakthrough Inelastic Demand
13. REVIEW LEARNING OUTCOME Setting the Right Price LO I Establish price goals Estimate demand, costs, and profits Choose a price strategy Fine-tune base price Set price $x.yy Evaluate results Skimming Status quo Penetration Low $ High $
14. The Legality and Ethics of Price Strategy Identify the legal and ethical constraints on pricing decisions LO 2
15. The Legality and Ethics of Price Strategy LO 2 Unfair Trade Practices Price Fixing Price Discrimination Predatory Pricing
16. The Legality and Ethics of Price Strategy LO 2 Unfair Trade Practices Laws that prohibit wholesalers and retailers from selling below cost. Price Fixing An agreement between two or more firms on the price they will charge for a product.
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18. Price Discrimination LO 2 The Robinson-Patman Act of 1936: Seller Defenses Cost Market Conditions Competition
19. Predatory Pricing LO 2 The practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. Predatory Pricing
20. Tactics for Fine-Tuning the Base Price Explain how discounts, geographic pricing, and other special pricing tactics can be used to fine-tune the base price LO 3
21. Tactics for Fine-Tuning the Base Price LO 3 Special pricing tactics Discounts Geographic pricing
22. Discounts, Allowances, Rebates, and Value-Based Pricing LO 3 Quantity Discounts Cash Discounts Functional Discounts Seasonal Discounts Promotional Allowances Rebates Zero Percent Financing Value-Based Pricing
23. Value-Based Pricing LO 3 Setting the price at a level that seems to the customer to be a good price compared to the prices of other options. Value-Based Pricing
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25. Geographic Pricing LO 3 Basing-point pricing Freight absorption pricing Zone pricing Uniform delivered pricing FOB origin pricing Online http://www.ups.com
26. Geographic Pricing LO 3 FOB Origin Pricing Uniform Delivered Pricing Zone Pricing Freight Absorption Pricing Basing-Point Pricing The buyer absorbs the freight costs from the shipping point (“free on board”). The seller pays the freight charges and bills the purchaser an identical, flat freight charge. The U.S. is divided into zones, and a flat freight rate is charged to customers in a given zone. The seller pays for all or part of the freight charges and does not pass them on to the buyer. The seller designates a location as a basing point and charges all buyers the freight costs from that point.
27. Other Pricing Tactics LO 3 Single-Price Tactic All goods offered at the same price Flexible Pricing Different customers pay different price Professional Services Pricing Used by professionals with experience, training or certification Price Lining Several line items at specific price points Leader Pricing Sell product at near or below cost Bait Pricing Lure customers through false or misleading price advertising Odd-Even Pricing Odd-number prices imply bargain Even-number prices imply quality Price Bundling Combining two or more products in a single package Two-Part Pricing Two separate charges to consume a single good
28. Consumer Penalties LO 3 http://www.princesscruises.com http://www.carnival.com Online An irrevocable loss of revenue is suffered Additional transaction costs are incurred Businesses Impose Consumer Penalties If...
33. Joint Costs LO 4 Joint Costs Costs that are shared in the manufacturing and marketing of several products in a product line.
34. Pricing during Difficult Economic Times Describe the role of pricing during periods of inflation and recession LO 5
35. Inflation LO 5 Cost-Oriented Tactics High Inflation Demand-Oriented Tactics
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38. Cost-Oriented Tactics LO 5 Increased Production Costs Decreased Demand Price Increase Maintaining a Fixed Gross Margin
39. Demand-Oriented Tactics LO 5 The use of discounts by salespeople to increase demand for one or more products in a line. Price Shading
40. Demand-Oriented Tactics LO 5 Strategies to Make Demand More Inelastic Cultivate selected demand Create unique offerings Change the package design Heighten buyer dependence
41. Recession LO 5 Bundling or Unbundling Value-Based Pricing
42. Supplier Strategies during Recession LO 5 Renegotiating contracts Offering help Keeping the pressure on Paring down suppliers
Notes: Setting the right price is a four-step process as shown in Exhibit 18.1.
Notes: The first step in setting the right price is to establish pricing goals. In Chapter 17, we learned that pricing objectives fall into three categories—profit oriented, sales-oriented, and status quo. These pricing goals are derived from the firm’s overall objectives. For example, a company wanting to be the dominant sales leader will pursue a sales-oriented pricing goal. A conservative organization may establish a status quo goal. A company wanting to maximize shareholder value will establish aggressive profit-oriented goals. A good understanding of the marketplace and of the consumer can tell a manager if a goal is realistic. All pricing objectives have trade-offs. Reaching the desired market share often means sacrificing short-term profit, because without careful management, long-term profit goals may not be met. Meeting the competition is the easiest pricing goal to implement. But demands and costs, the lifecycle stage, and other considerations can not be ignored when creating pricing objectives.
Notes: The price strategy sets a competitive price in a specific market segment. Consequently, changing a price strategy can require dramatic alterations in the marketing mix, including the product itself. Pricing a new product depends on the market conditions and the other elements of the marketing mix. For example, introducing a product resembling several others in the marketplace will have restricted pricing freedom. In contrast, introducing a product with no close substitutes will have considerable pricing freedom. Most companies do not do a good job of researching price strategies. In fact, recent studies showed that only 8 percent of the companies surveyed conducted serious pricing research to support the development of an effective pricing strategy.
Notes: Companies that plan for creating a price strategy can select from three basic approaches: price skimming, penetration pricing, and status quo pricing. A discussion of each type follows.
Notes: Price skimming is a pricing policy whereby a firm charges a high introductory price, often coupled with heavy promotion. The term is derived from the phrase “skimming the cream off the top.” Companies often use price skimming for new products when the product is perceived as having unique advantages. As a product enters different stages of its life cycle, the price may decrease to reach larger market segments. Additional situations when price skimming is successful are listed on this slide. Firms often feel it is better to test the market at high prices and then lower the price if sales are too slow. A price skimming strategy will encourage competitors to enter the market. Discussion/Team Activity: List companies and/or products that utilize a price skimming strategy.
On Line Southwest Airlines It’s no secret that Southwest Airlines has some of the cheapest fares around the nation. But just how much cheaper are they? The next time you travel, take the time to compare Southwest’s prices with another carrier’s. Has your regular airline met the challenge of Southwest’s penetration pricing strategy? If so, how? Notes: Penetration pricing is at the opposite end of the spectrum from price skimming. By charging a low price for a product, a larger share of the market is captured, resulting in lower production costs. It does, however, mean lower profit per unit, and a higher volume of sales is required to reach the break-even point. Penetration pricing does tend to discourage competition and is effective in a price-sensitive market.
Notes: Status quo pricing means meeting the competition’s prices by charging an identical price or very close to the competition’s price. It is a simple method of pricing, but the strategy may ignore demand and/or cost. However, if the firm is small, meeting the competition’s prices may be the safest route to long-term survival.
Notes: Some pricing decisions are subject to government regulation. Therefore, price strategy should be determined with a knowledge of laws that may limit decision making.
Notes: The issues that limit pricing decisions are unfair trade practices, price fixing, price discrimination, and predatory pricing.
Notes: In over half the states, unfair trade practice acts put a floor under wholesale and retail prices, and selling below cost is illegal. Wholesalers and retailers must take a certain minimum percentage markup on their combined merchandise cost and transportation cost. The most common markup figures are 6 percent at the retail level and 2 percent at the wholesale level. If a specific wholesaler or retailer can provide conclusive proof that operating costs are lower than the minimum required figure, lower prices may be allowed. The intent of unfair trade practice acts is to protect small firms from retail giants like Wal-Mart and Target, which operate efficiently on razor-thin margins. State enforcement of unfair trade practice laws has generally been lax, because low prices benefit local consumers. ------------------------------------------------------ Price fixing is illegal under the Sherman Act and the Federal Trade Commission Act. Cases involving price fixing include: * ISK Japan, for conspiring to fix prices for video magnetic iron oxide particles * Gemstar-TV Guide International *Hoechst AG, for suppressing competition for an industrial chemical used in production * Uniroyal, for fixing prices on neoprene *Hoffman-LaRoche for price fixing in the vitamin industry
Notes: The Robinson-Patman Act provides three defenses for the seller charged with price discrimination. In each case the burden is on the defendant to prove the defense . Cost: A firm can charge different prices to different customers if the prices represent manufacturing or quantity discount savings. Market conditions: Price variations are justified if designed to meet fluid product or market conditions. Examples include the deterioration of perishable goods, the obsolescence of seasonal products, a distress sale under court order, or a legitimate going-out-of-business sale. Competition: A reduction in price may be necessary to stay even with the competition.
Notes: Predatory pricing is illegal under the Sherman Act and the Federal Trade Commission. However, proving the use of this practice is difficult and expensive. The Justice Department must show that the predator explicitly tried to ruin a competitor and that the predatory price was below the predator’s average variable cost.
Notes: The base price is the general price level at which the company expects to sell a good or service. The general price level is correlated with the pricing policy: above the market, at the market, or below the market. The final step is to fine-tune the base price. Fine tuning techniques include discounts, geographic pricing, and special pricing tactics.
Notes: A base price can be lowered through the use of discounts and the related tactics of allowances, rebates, low or zero percent financing, and value-based pricing. Discounts are used to encourage customers to do what they would not ordinarily do, such as pay cash, take delivery out of season, or perform certain functions with a distribution channel. The most common tactics are: Quantity discounts with lower prices for buying in multiple units of above a specified dollar amount. Cash discounts offered for prompt payment of a bill Functional discounts (trade discounts) are offered when channel intermediaries perform a service for the manufacturer. Seasonal discounts are lower prices for buying merchandise out of season. Promotional allowances (or trade allowance) are payments to dealers for promoting the manufacturer’s products. Rebates are cash refunds given for purchasing a product within a specified period. Zero percent financing offers no interest charge to increase sales. However, it does cost the manufacturers. Value-based pricing sets the price at a level that seems to the customer to be a good price compared to other prices.
Notes: The basic assumption with value-based pricing is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers.
Notes: Pricing products too low reduces company profits. This happens for two reasons: The company is attempting to buy market share through aggressive pricing. Managers have a tendency to make decisions that can be justified objectively. As a result, pricing decisions are made based on current costs, projected short-term share gains, or current competitive prices rather than on long-term profitability.
On Line United Parcel Service Go to UPS’s Web site and do some quick cost comparison on sending the same package to a friend in town and to a friend out-of-state. Does the difference in cost surprise you? Do you think it is justified? Why or why not? Notes: The cost of freight can greatly affect the total cost of a product. The common methods of geographic pricing are listed on this slide.
Notes: Other pricing tactics are unique and defy neat categorization. Managers use these tactics to stimulate demand for specific products, to increase store patronage, and to offer a wider variety of merchandise at a specific price point. These pricing tactics are described on this slide. Discussion/Team Activity: Discuss products and/or businesses that utilize these pricing tactics.
On Line Princess Cruises Carnival Cruises How up-front are companies about their pricing penalties? Compare what you find out at Princess Cruises’ Web page (type “penalties” into the search box) with what you find on Carnival Cruises’ page. From a marketing standpoint, do you think it is better to hide penalties in the fine print or to clearly let the customer know in advance? Notes: More businesses are adopting consumer penalties—extra fees paid by consumers for violating the terms of a purchase agreement. Refer to exhibit 18.2 for a list of common consumer penalties in different industries.
On Line Beauty.com Does Beauty.com use a product line pricing strategy? Choose a brand and view the product list and pricing sheet. What evidence do you see of product line pricing? Of other pricing strategies? Notes: In product line pricing, the manager tries to achieve maximum profits for the entire line rather than for a single component of the line.
Notes: In setting product line prices, the manager first determines the relationship among the products in the line: Complementary: An increase in the sale of one good causes an increase in demand for the complementary product. Substitutes: Two products in a line can be substitutes for each other. If buyers buy one item in the line, they are less likely to buy a second item in the line. Neutral: A neutral relationship can exist between two products. Demand for one of the products is unrelated to demand for the other.
Notes: If costs are shared in the manufacturing and marketing of several products in the product line, product pricing is more difficult. Some common assignments of joint costs include a weight basis, market value, or quantity sold. Discussion/Team Activity: Name products that may require joint cost pricing.
Notes: One common cost-oriented tactic is culling products with a low profit margin. However this tactic may backfire for the three reasons listed on this slide.
Notes: Cost-oriented tactics include delayed-quotation pricing, which is used for industrial installations and accessory items. Price is not set until the item is either finished or delivered. Examples: Builders of nuclear power plants, ships, airports, and office towers. Escalator pricing is similar to delayed-quotation pricing in that the final selling price reflects cost increased incurred between the time an order is placed and the time delivery is made. Examples: Extremely complex products that take a long to produce or with new customers. Another tactic is to hold prices constant but add new fees.
Notes: Any cost-oriented pricing policy that tries to maintain a fixed gross margin under all conditions can lead to a vicious circle, as shown in the diagram on this slide. A price increase will result in decreased demand, which in turn increases production costs because of lost economies of scale. Increased production costs require a further price increase, etc.
Notes: Demand-oriented tactics use price to reflect changing patterns of demand caused by inflation or high interest rates. Often price shading becomes habitual and is done routinely without much forethought.
Notes: To make the demand for a good or service more inelastic and to create buyer dependency, a company can use the strategies as shown on this slide: Cultivate selected demand: Target prosperous customers who will pay extra for convenience or service. Example: Neiman Marcus Create unique offerings: By studying buyers’ needs, the seller can design distinctive products to fit a buyers’ needs and establish a beneficial relationship. Example: Value-added or multi-ingredient cereals Change the package design: Companies pass on higher costs by shrinking the product sizes but keep prices the same. Heighten buyer dependence: Provide additional value-added services and training with product offerings to freeze out competition and support higher prices. Example: Owens-Corning Fiberglas integrated insulation service (from feasibility studies to installation)
Notes: Effective pricing tactics during recession are value-based pricing and bundling. Value-based pricing stresses to customers that they are getting a good value for their money. Bundling or unbundling of features or services gives a perception of higher value. Bundling can be demonstrated in vacation packages that include lodging, meals, massages, etc.
Notes: In a recession, prices often fall so that companies can maintain demand for their products. Falling prices are an incentive to lower costs since falling prices mean lower profits or no profits. Suppliers can be excellent sources of cost savings. Some ways companies can use cost-saving strategies with suppliers are listed on this slide. Renegotiating contracts: Demanding lower prices or rebidding the contracts. Offering help: Help suppliers’ plants reorganize and increase productivity. Keeping the pressure on: Set annual, across-the-board cost-reduction targets. Paring down suppliers: Reduce the number of suppliers and boost purchases from those that remain.
