12. Pricing (Chapter 16)
Terms in this set (27)
Summary of this chapter
1. Internal/External Factors of Price
2. Pricing Objectives
4. Cost-based Pricing
5. New Product Pricing
6. Methods of Pricing
7. Product Mix Pricing Strategies
8. Price Adjustment Strategies
What is price?
- $ - what you pay for something or...
- The value that you exchange for the benefits of having or using the product/service (i.e. time, psychological costs, other resources)
Value= benefits - cost
Internal Factors of Price
1. Marketing Objectives
- to maximize profit
- to gain market share
- to infer a level of quality
- to survive
2. Marketing Mix Strategy:
price needs to be consistent with other 3P's (needs to reflect advertising, etc.)
3. Costs: your costs affect your profit, so set the optimal price
External Factors of Price
1. Demand for your product
- Competitor's prices
- Strength of competition
- Cost of components (natural resources)
- Economic conditions
1. Profit- Oriented (SUVs)
- profit maximization
- satisfactory profits
- return on investment
2. Sales- Oriented (game consoles)
- market share
- sales maximization
3. Status Quo
- maintaining price
- meeting competitions price
Substitute or Complement?
1. Substitutes: When a decrease in price on one product results in a decrease in sales of a second product
2. Complement: When a decrease in price on one product results in a increase in sales of a second product
Tells us how much the demand for a product will change with a change in price
E= (%change in quantity demanded of good "A") over (% change in price of good "A")
Factors That Affect Elasticity
- Availability of substitutes
- Price relative to purchasing power
- Product durability
- A product's other uses
Elasticity of Demand
1. Elastic Demand: Consumers buy more or less of a product when the price changes ( Price goes DOWN, revenue goes UP)
2. Inelastic Demand: An increase or decrease in price will not significantly affect demand (price goes DOWN, revenue goes DOWN
3. Unitary Elasticity: An increase in sales exactly offsets a decrease in prices, and revenue is unchanged ( Price goes UP or DOWN, revenue stays the SAME)
- If demand greatly changes with a price change, the demand is elastic
- This describes products that are price-sensitive and have many substitutes
Ex: Gum, Frozen Pizza, Brands of Gasoline
2. Relatively Elastic: A relatively small decrease in price results in a substantial increase in quantity demanded.
3. When the elasticity of a good is INELASTIC, a price DECREASE leads to DECREASE on total REVENUE
- If demand hardly changes with a price change, the demand is inelastic
- This describes products that are less price-sensitive and have very few substitutes
Ex: Cigarettes, medicine, gasoline
2. Relatively Inelastic: A relatively large increase in price results in only a small decrease in quantity demanded.
Goal of Marketing
- Create strong brands.
- Create a competitive advantage.
- Change the good to get the best of Elastic and Inelastic demand.
Methods of Cost-based Pricing
Methods for determining an initial price for the product or service
1. Markup pricing
keystoning (double the cost)
2. Break-even pricing
3. Profit maximization pricing
Markup Pricing (Formulas)
1. Setting price where price = markup + cost
* Selling price= (cost) over (1 - markup on selling price)
*Markup on selling price = (selling price - cost) over (selling price)
*Cost = (1 - markup on selling price) x ( selling price)
1. Break-even quantity = ( total fixed cost) over (fixed cost contribution)
2. Break-even analysis provides a quick estimate of how much the firm must sell to break even and how much profit can be earned if a higher sales volume is obtained. However, it has limitations such as the difficulty in determining whether a cost is fixed or variable. Additionally, break-even analysis ignores demand.
- Marginal Cost = Marginal Revenue
- In an ideal situation, marketers will operate at the point where marginal costs (MC) equal marginal revenue (MR).
Other Determinants of Price
- Stages of the
- Product Life Cycle
- Promotion Strategy
- Perceived Quality
- High prices may induce firms to enter the market
- Competition can lead to price wars
- Global competition may force firms to lower prices
- Competition varies during the product life cycle. Although a firm may not have competition at first, the high prices obtained may induce other firms to enter the market.
- Sometimes competition can lead to price wars.
- Global competition has often forced firms to lower prices. Even Wal-mart has seen price cutting by the second largest world-wide competitor Carrefour.
- Offer a larger profit margin or trade allowance
- Use exclusive distribution
- Avoid business with price-cutting discounters
- Develop brand loyalty
- Sell against the brand
- Buy gray-market goods
3. Selling against the
Brand: Stocking well-known branded items at high prices in order to sell store brands at discounted prices.
- Adequate distribution for a new product can be obtained by offering a larger-than-usual profit margin to distributors, or by offering a large trade allowance to defray the costs of promotion.
- However, some distributors use "selling against the brand" strategies to promote their own private-label brands. They place well-known brands at high prices while offering other brands at higher prices.
- Distributors may also go outside traditional channels and buy "gray-market goods" at lower prices so they can sell the goods with a large markup or at a reduced price.
1. Profitability - setting price to meet a specific profit target.
2. Volume - If a company can reduce its cost through achieving economies of scale and/or the experience curve they may opt to price its products low in order to generate significant volume. This is similar to "penetration pricing". There are numerous reasons for using this type of strategy: gain market share to limit competitors from entering; or to have an entry point in a crowded market. Nintendo used volume pricing with its Wii game system and quickly exceeded the sales volume over PlayStation and Xbox.
3. Meeting Competition - Allows a company to position its product close to a competitor, if price is a key differentiator.
4. Prestige - Many brands enjoy perceptions of high quality or luxury. Since price is often used by buyers as a proxy for quality, high prices can help maintain the desired image.
How to Set a Price on a Product or Service
1. Establish pricing goals
2. Estimate demand, costs, and profits
3. Choose a price strategy
4. Fine-tune with pricing tactics
5. Set price $x.yy
6. Evaluate results
New-Product Pricing Strategies
1. Market-skimming pricing
- High initial price
- Innovators and early adopters
2. Market-penetration pricing
- Low initial price
- Attract large number of buyers quickly
3. Status quo
- Suggest similar quality and value as competition
Price skimming is where a products price is set high upon its introduction and then lowered over time. This is done so as to generate as much profit as possible before competitors enter the market. Innovators and early adopters are likely to pay a higher price for the latest cool products. The key here is that prices will fall over time as competitors enter the market.
- Product outperforms others
- Early adopters value product
- Demand is inelastic
- Expected demand can't be met
- High quality is desired position
Penetration pricing is pricing a product low so as to gain market share quickly
-This could be to take advantage of experience curve, where manufacturing costs are reduced as more units are produced. A way to get this point across to students is to asked them about their skill level the first time they played a particular video game. Most will admit to doing poorly the first time or two. But over time they gain the skills and knowledge needed to become advanced players. It is the same way with employees. The more times they perform as task the quicker they become. As the employees become more skilled they can produce more units in less time, thereby reducing cost.
- Higher volume reduces costs
- Low price deters competitors
- Demand is elastic
- Buyers price sensitive
- Competitor imitation possible
New-Product Pricing Strategies (Chart)
- Premium Strategy: higher quality and higher price
- Good-value strategy: higher quality and lower price
- Overcharging strategy: lower quality and higher price
- Economic strategy: lower quality and lower price
Product Mix Pricing Strategies
1. Portfolio pricing
- Levels of Price Points
- Pay more for extras
- Hotel rooms
2. Captive - product pricing
- Razor and blades mentality
3. Price bundling
- Combine related goods, sell for one price, "package deals"
- Could be example of co-branding
Price Adjustment Strategies
1. Discounts, Allowances, Rebates
a. Cash - pay cash upfront
b. Quantity - buy in bulk
c. Seasonal -
- buy during non-peak times
d. Promotional allowance -
- $ to dealer for promoting
2. Flexible (variable) pricing
a. Different segments pay different rates
- Senior citizen movie rates
- Kids' rates at a restaurant
b. Off-peak daily rate changes
- Movies, long-distance, electricity
3. Psychological (odd-even) pricing
Ta. he 99 principle
b. Reference pricing
- What you expect to pay for a product in that category (SUV = ?)
c. Unit pricing
states price in a recognized unit of measurement
4. Other pricing tactics
a. Single-price tactic (Everything $1)
b. Bait pricing
c. Two-part pricing - country club
d. Loss leader (leader pricing)