CHAPTER 22
Setting Prices
Lecture Outline
(Transparency Figure 22A: Chapter Outline)
The price-setting process involves six steps that provide a logical way to analyze the effectiveness of price in the marketing mix and the contributions of price to the organization’s objectives.
(Transparency Figure 22.1)
I. Development of Pricing Objectives
A. Pricing objectives are goals that describe what a firm wants to achieve through pricing efforts.
(Transparency Table 22.1)
1. Developing pricing objectives is an important task because pricing objectives form the basis for decisions about other stages of pricing.
2. Pricing objectives must be consistent with organizational and marketing objectives.
3. Pricing objectives influence decisions in many functional areas, including finance, accounting, and production.
4. A marketer can use both short- and long-term pricing objectives and can employ one or more multiple pricing objectives.
B. Survival
A fundamental pricing objective is survival.
1. Most organizations will tolerate short-run losses, internal upheaval, and many other difficulties if these conditions are necessary for survival.
2. Because price is such a flexible and convenient variable to adjust, it sometimes is used to increase sales volume to levels that match the organization’s expenses.
C. Profit
1. The objective of profit maximization is rarely operational because it is difficult to measure its achievement.
2. Specific profit objectives may be stated in terms of actual dollar amounts or in terms of a percentage of sales revenues.
D. Return on Investment
1. Pricing to attain a specified return on the company’s investment is also a profit-related pricing objective.
2. Unfortunately, most pricing objectives based on return on investment are achieved by trial and error because not all cost and revenue data needed to project the return on investment are available when prices are set.
E. Market Share
1. Many firms establish pricing objectives to maintain or increase market share—a product’s sales in relation to total industry sales—in part because they recognize that high relative market share often translates into higher profits.
2. Maintaining or increasing market share need not depend on growth or industry sales.
a) An organization’s sales volume may increase while its market share within the industry decreases, if the overall market is growing.
b) However, an organization’s market share can also increase even when sales for the industry are decreasing.
F. Cash Flow
Some organizations set prices to recover cash as quickly as possible.
1. Financial managers are interested in quickly recovering capital that has been spent to develop products.
2. A possible disadvantage of this pricing objective is high prices, which might enable competitors with lower prices to gain a large share of the market.
G. Status Quo
In some instances, an organization may be in a favorable position and therefore set an objective of status quo.
1. Status quo objectives can focus on several dimensions, including maintaining a certain market share, meeting competitors’ prices, achieving price stability, or maintaining a favorable public image.
2. A status quo pricing objective can reduce a firm’s risks by helping stabilize demand for its products.
3. The use of status quo pricing objectives sometimes minimizes price as a competitive tool, which can lead to a climate of nonprice competition within an industry.
H. Product Quality
An objective of product quality leadership in the market normally results in charging a high price to cover the high product quality and, perhaps, the high cost of research and development.
II. Assessment of the Target Market’s Evaluation of Price
A. The importance of price depends on the type of product, the type of target market, and the purchase situation.
B. Value combines a product’s price and quality attributes, which are used by customers to differentiate competing brands.
(Transparency Figure 22F)
C. Understanding the importance of a product to customers, as well as their expectations of quality and value, helps a marketer correctly assess the target market’s evaluation of price.
III. Evaluation of Competitors’ Prices
A. Learning competitors’ prices may be a regular function of marketing research.
B. Marketers in an industry in which price competition prevails need competitive price information to ensure that their organization’s prices are the same, or lower than, their competitors’ prices.
C. An organization may set its prices slightly above the competition to give its products an exclusive image, or it may use price as a competitive tool and price its products below those of competitors.
IV. Selection of a Basis for Pricing
The three major dimensions on which prices can be based are cost, demand, and competition. The selection of the basis to be used is affected by the type of product, the market structure of the industry, the brand’s market share position relative to competing brands, and customer characteristics.
(Transparency Figure 22B)
A. Cost-Based Pricing
When using cost-based pricing, a firm determines price by adding a dollar amount or a percentage to the cost of the product. Cost-based pricing is straightforward and easy to implement.
(Transparency Figure 22C)
1. Cost-Plus Pricing. Cost-plus pricing is a method whereby the seller’s costs are determined, and then a specified dollar amount or percentage of the cost is added to the seller’s cost to establish the price.
a) This is appropriate when production costs are unpredictable or a long production period is needed.
b) One pitfall for the buyer is that the seller may increase costs to establish a larger profit base.
c) For industries in which cost-plus pricing is common and sellers have similar costs, price competition may not be especially intense.
2. Markup Pricing. Through markup pricing, a product’s price is derived by adding a predetermined percentage of the cost, called markup, to the cost of the product.
a) Markups can be stated as a percentage of the cost or as a percentage of the selling price.
b) Markups usually reflect expectations about operating costs, risks, and stock turnovers.
c) To the extent that retailers use similar markups for the same product category, price competition is reduced.
B. Demand-Based Pricing
With demand-based pricing, customers pay a higher price when demand for the product is strong and a lower price when demand is weak.
(Transparency Figure 22C)
1. To use demand-based pricing, a marketer must be able to estimate the amounts of a product consumers will demand at different prices; effectiveness depends on the marketer’s ability to estimate demand accurately.
(Building Customer Relationships: Wireless Companies Ring up Competitive Pricing Strategies)
2. Compared with cost-based pricing, demand-based pricing places a firm in a better position to reach higher profit levels assuming that buyers value the product at levels sufficiently above the product’s cost.
C. Competition-Based Pricing
Competition-based pricing is pricing that is influenced primarily by competitors’ prices.
(Transparency Figure 22C)
1. The importance of this method increases when competing products are relatively homogeneous and the organization is serving markets in which price is a key purchase consideration.
2. This pricing technique can help attain the pricing objective of increasing sales or market share.
V. Selection of a Pricing Strategy
A pricing strategy is an approach or a course of action designed to achieve pricing and marketing objectives. Generally, pricing strategies help marketers solve the practical problems of establishing prices.
(Transparency Table 22.2)
A. Differential Pricing
1. An important issue in pricing is whether to use a single price or multiple prices for the same product.
a) Using a single price has several benefits, including that it is easily understood and it reduces the chance of an adversarial relationship developing between marketer and customer.
b) A single price also creates some challenges: if a single price is too high, some customers may not be able to afford the product; if it is too low, the firm loses revenue from customers who would have paid more had the price been higher.
2. Differential pricing is charging different prices to different buyers for the same quality and quantity of product. The market must consist of multiple segments with different price sensitivities, and the pricing method should be used in a way that avoids confusing or antagonizing customers.
a) Negotiated Pricing. Negotiated pricing is establishing a final price through bargaining between the seller and customer. Even when there is a predetermined stated price or a price list, negotiated pricing may still be used to establish the final sales price.
b) Secondary-Market Pricing. Secondary-market pricing involves setting a price for use in another market that is different from the price charged in the primary target market. Often, the price charged in the secondary market is a lower price. However, when the costs of serving a secondary market are higher than normal, secondary-market customers may have to pay a higher price.
c) Periodic Discounting. Periodic discounting is the temporary reduction of prices on a patterned or systematic basis. Seasonal changes, model year changes, or holidays may be reasons for the systematic price reductions.
d) Random Discounting. Random discounting is temporarily reducing a regular-priced product using an unsystematic time schedule. This is done to attract new customers and reduce predictability of price reductions by current customers.
e) Retailers often employ "tensile pricing," which is using a broad statement about a price reduction as opposed to detailing specific price amounts.
B. New-Product Pricing
Setting the base price for a new product is a necessary part of formulating a marketing strategy and is one of the most fundamental decisions in the marketing mix.
1. Price Skimming. Price skimming is charging the highest possible price that buyers who most desire the product will pay. Price skimming
a) Can generate much-needed initial cash flows to help offset sizable development costs.
b) Protects the marketer from problems that arise when the price is set too low to cover costs.
c) Can help keep demand consistent with a firm’s production capabilities.
2. Penetration Pricing. Penetration pricing is setting the price lower than competing brands to penetrate a market and gain a significant market share quickly. Penetration pricing
a) Puts the marketer in a less flexible position because it is more difficult to raise a penetration price than to lower or discount a skimming price.
b) Can be especially beneficial when a marketer suspects that competitors could enter the market easily.
C. Product-Line Pricing
Product-line pricing is establishing and adjusting prices of multiple products within a product line. A marketer’s goal here is to maximize profits for an entire product line rather than to focus on the profitability of an individual product.
1. Captive Pricing. Captive pricing involves pricing the basic product in a product line low, but pricing related items at a higher level.
2. Premium Pricing. Premium pricing entails pricing higher quality or more versatile products higher than other models in the product line.
3. Bait Pricing. Bait pricing occurs when a marketer prices an item in the product line low with the intention of selling a higher-priced item in the line. The lower-priced item will attract customers into the store, while the marketer hopes that once in the store, the customer will purchase the higher-priced one.
4. Price Lining. With price lining, the organization sets a limited number of prices for selected groups or lines of merchandise. The basic assumption in price lining is that demand is inelastic for various groups or sets of products.
(Transparency Figure 22.2)
D. Psychological Pricing
Psychological pricing attempts to influence a customer’s perception of price to make the product’s price more attractive.
1. Reference Pricing. Reference pricing is pricing a product at a moderate level and positioning it next to a more expensive model or brand. Reference pricing is based on the "isolation effect," which says that an alternative is less attractive when it appears by itself compared to when it appears with other alternatives.
2. Bundle Pricing. Bundle pricing is the packaging together of two or more usually complementary products to be sold for a single price. The customer often values the convenience of purchasing a combination of bundled products.
3. Multiple-Unit Pricing. Multiple-unit pricing occurs when two or more of the same product are packaged together and sold for a single price. A company uses multiple-unit pricing to attract new customers to its brand and, in some instances, to increase consumption of its brands.
4. Everyday Low Prices (EDLP). Everyday low prices requires setting a low price for products on a consistent basis.
a) Generally, prices are set far enough below competitors’ prices to make customers confident they are receiving a fair price.
(Building Customer Relationships: Family Dollar Stores’ Strategy Is Driven by Everyday Low Prices)
b) A major problem with ELDP is that customers have mixed responses to it: customers seem to have been "trained" to seek and to expect deeply discounted prices.
(Transparency Figure 22D)
5. Odd-Even Pricing. Odd-even pricing influences the buyers’ perceptions of the price or the product by ending the price with certain numbers. Odd-even pricing assumes that more of a product will be sold at $99.95 than at $100 because customers will think the product is a bargain.
a) There are no substantial research findings to support the notion that odd prices produce greater sales.
b) An even price supposedly will influence a customer to view the product as being a high-quality, premium brand.
6. Customary Pricing. With customary pricing, certain goods are priced primarily on the basis of tradition.
7. Prestige Pricing. With prestige pricing, prices are set artificially high to convey a prestige or quality image.
(Transparency Figure 22E)
E. Professional Pricing
Professional pricing includes fees set by people who have great skill or experience in a particular field or activity.
1. Professionals who provide certain services or products believe their fees should not relate directly to the time and effort spent in specific cases; they charge a standard fee regardless of the problems involved in performing the job.
2. The concept of professional pricing carries with it the idea that professionals have an ethical responsibility not to overcharge customers.
F. Promotional Pricing
Price, as an ingredient in the marketing mix, is often coordinated with promotion. The two variables sometimes are so interrelated that the pricing policy is promotion-oriented.
1. Price Leaders. Products priced below the usual markup, near cost, or below cost are price leaders; management hopes that sales of regularly priced merchandise will more than offset the reduced revenues from the price leaders.
2. Special-Event Pricing. With special-event pricing, advertised sales or price cutting is used to increase sales volume and is linked to a holiday, season, or special event.
3. Comparison Discounting. Comparison discounting is the pricing of a product at a specific level and comparing it to a higher price. The Federal Trade Commission has established guidelines for comparison pricing in order to dissuade deceptive pricing practices.
VI. Determination of a Specific Price
A. A pricing strategy will yield a certain price; however, this price may need refinement to make it consistent with pricing practices in a particular market or industry.
B. Pricing remains a flexible and convenient way to adjust the marketing mix.