BMGT 411: Week 8

Kottler: Chapters 12 - Pricing StrategiesWood: Chapter 7 - Pricing Strategies

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BMGT 411: Chapter 12

Developing Pricing Strategies and Programs

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Chapter Questions

• How do consumers process and evaluate prices?

• How should a company set prices initially for products or services?

• How should a company adapt prices to meet varying circumstances and opportunities?

• How should a company initiate a price change and respond to a competitor’s price change?

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Premium Pricing

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Synonyms for Price

• Rent

• Tuition

• Fee

• Fare

• Rate

• Toll

• Premium

• Honorarium

• Special assessment

• Bribe

• Dues

• Salary

• Commission

• Wage

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Internet: Empowers Consumers

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Common Pricing Mistakes

• Determine costs and take traditional industry margins

• Failure to revise price to capitalize on market changes

• Setting price independently of the rest of the marketing mix

• Failure to vary price by product item, market segment, distribution channels, and purchase occasion

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Consumer Psychology and Pricing• Reference prices: Comparing an observed price to an internal reference

price they remember or an external frame of reference such as a posted “regular retail price”

• Kohl’s uses reference pricing to make their sales look even bigger

• Price-quality inferences: When consumer’s use price as an indicator of quality

• Luxury cars, perfume, designer clothes

• Price endings: $299 Vs $300, consumers process prices left to right, $299 seems like it is in the $200 range Vs $300 range

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Steps in Setting Price

1. Select the price objective

2. Determine demand

3. Estimate costs

4. Analyze competitor price mix

5. Select pricing method

6. Select final price

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Step 1: Select the price objective

1. Survival Pricing: Often a short term objective if they are plagued with overcapacity, intense competition, or changing customer wants (Blackberry?)

2. Maximum Current Profit: Estimating the demand, competition and choose a price that yields a maximum profit, cash flow, or ROI (Business to Business markets where there is lower competition)

3. Market Penetration Pricing: Setting the lowest price, leading to higher volume, lower unit costs, and higher long run profit (Walmart, Target)

4.Market-Skimming Pricing: Prices start high, and as demand increases, prices slowly drop over time (Roku Box)

5. Product Quality Leader Pricing: High prices that come with tastes, quality, or customer service (BMW, Apple)

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Step 2: Determine demand

• Price sensitivity: How customers react to higher and lower prices

• Rule of thumb: less sensitive to low cost items and items bought infrequently

• Because food is purchased so often, it is often noticed and very sensitive to price changes

• Estimate demand curves: Estimating different demands based on different pricing strategies. Often meeting in the middle to set prices

• Price elasticity of demand: Depends on how responsive, or elastic, demand is to a change in price

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Inelastic Demand

Demand hardly changes with a small change in price - demand is inelastic - If gas went up 5%, demand would almost remain unchanged

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Elastic Demand

When demand changes considerable when prices change, we call that demand is elastic- Example - Beef and other Food sources (Because there are often cheaper substitutes)

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Table 12.1 Factors Leading to Less Price Sensitivity

• The product is more distinctive

• Buyers are less aware of substitutes

• Buyers cannot easily compare the quality of substitutes

• Expenditure is a smaller part of buyer’s total income

• Expenditure is small compared to the total cost

• Part of the cost is paid by another party

• Product is used with previously purchased assets

• Product is assumed to have high quality and prestige

• Buyers cannot store the product

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Step 3: Estimating Costs

• Types of costs:

• Fixed Costs: Overhead, do not vary with increased production (Rent, salaries, etc)

• Variable Costs: Varies directly with the level of production (Raw materials)

• Total Costs: The sum of the fixed costs and variable costs for a given level of production

• Average Cost: The cost per unit at the total level of production

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Step 3: Estimating Costs

Figure 12.1 Cost per Unit as a Function of Accumulated Production

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Target CostingBringing down the costs to target levels marketers want to achieve

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Step 4: Analyzing Competitor’s Costs,

Prices, and Offers 18

Step 5: Selecting a Pricing Method

• Markup pricing

• Target-return pricing

• Perceived-value pricing

• Value pricing

• Going-rate pricing

• Auction-type pricing

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Markup Pricing

• Unit Cost = Variable Cost + Fixed Costs/Unit Sales

• = $10 + $300,000/50,000 = $16 Per Unit

• If they wish to earn 20 percent markup, the formula is as follows

• Markup Price = Unit Cost/ (1 - Desired return on sales)

• = $16 / (1 - .2) = $20

Variable Cost Per Unit: $10

Fixed Costs: $300,000

Expected Unit Sales: 50,000

Invested Capital = $1,000,000

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Target Return Pricing

• Target Return Cost = Unit Cost + (Desired Return x Invested Capital)/ Unit Sales

• If they wish to earn 20 percent markup, the formula is as follows

• $16 + (.2 x $1,000,000)/50,000 = $20

Variable Cost Per Unit: $10

Fixed Costs: $300,000

Expected Unit Sales: 50,000

Invested Capital = $1,000,000

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Target Return Pricing

Figure 12.3 Break-Even Chart for Determining Target-Return Price and Break-Even Volume

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Target Return Pricing - Break Even Point

• Break Even Volume = Fixed Cost / (Price - Variable Cost)

• = $300,000/ ($20 - $10) = 30,000

Variable Cost Per Unit: $10

Fixed Costs: $300,000

Expected Unit Sales: 50,000

Invested Capital = $1,000,000

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Perceived Value Pricing

Basing the price on the customer’s perceived value

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Value Pricing

Winning loyal customers by charging a fairly low price for a quality offering

EDLP Model - Everyday Low Price

High Low Pricing - Charges higher prices on everyday items partnered with sales

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Other Pricing Methods

• Going Rate Pricing: Charging based mostly on what other competitors are charging, not very scientific

• Popular in business to business marketing with little competition, and service industries (Plumbers, etc)

• Auction Pricing: Bidding the price up or down

• English - One seller, many buyers (Ebay Model)

• Dutch, or Reverse - Buyer announces something they want to buy, and sellers compete to offer the lowest price (Popular in the printing industry)

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Step 6: Selecting the Final Price

• Impact of other marketing activities: Prices must align with overall brand strategy, image, and customer expectations

• Company pricing policies: Cannot alienate customers with pricing that does not fit the companies model

• Impact of price on other parties: Will partners be left with room to make a profit as well? They may not carry the product if not

• In 2009, Costco stopped selling Coke due to a pricing dispute

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Other Pricing Considerations

Geographical Pricing: Pricing varies by locationVery common in the hotel business, same hotel in different locations are very different prices

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Other Pricing Considerations

• Discount: Discount for paying bills within a desired timeframe

• Quantity discount: Discount to buyers who buy large volumes

• Functional discount: Discount offered for selling or storing a product

• Seasonal discount: Discounts on out of season goods

• Allowance: Example, trade ins, discounts for displaying product

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Promotional Pricing Tactics

• Loss-leader pricing

• Special-event pricing

• Cash rebates

• Low-interest financing

• Longer payment terms

• Warranties and service contracts

• Psychological discounting

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Differentiated Pricing

• Customer-segment pricing: Students or Senior Citizen Pricing

• Product-form pricing: Different versions of the product are priced differently

• Channel pricing: Different pricing for different channels (Coke in vending, restaurants, C-store)

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Key Concepts from the Marketing Plan Handbook

Chapter 7 - Pricing Strategies

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Value

• Need to research and analyze value.

• Consider how the product’s value will be communicated.

• Customers’ perceptions of value and price sensitivity can be used to deal with imbalances in supply and demand.

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Price Elasticity (cont’d)

Change in Price Inelastic Demand Elastic Demand

Small Increase Demand drops slightly

Demand drops significantly

Small Reduction Demand rises slightly

Demand rises Significantly

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Factors Impacting Elasticity

• Customers are less sensitive to price when:

• It is a relatively small amount of product

• Comparisons to possible substitutes are not easy

• Switching costs are involved

• The product’s quality, status, or another benefit justifies the price

• The cost is shared with others

• Perceive the price as fair

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Samples of Pricing Objectives

Type of Objective Sample Pricing ObjectiveFinancial For profitability: Set prices to achieve gross

margin of 40%.

Marketing For higher market share: Set prices to achieve a market share increase of 5% within 6 months.

Societal For philanthropy: Set prices to raise $10,000 for charity during the second quarter of the year.

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Sample of Consumer Pricing in the Retail Channel

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Some examples of ethical issues in pricing:

• Is it ethical to raise prices during an emergency, when products may be scarce or particularly valuable?

• Should a company set a high price for an indispensable product, knowing that some customers will be unable to pay?

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Costs and Break-Even Objectives

• Costs typically establish the theoretical “floor” of the pricing range.

• Break-even point: the sales level at which revenues cover costs.

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Break-Even Example

• Break-even volume = fixed cost/price-variable cost.

• Example:

• Given:

• Fixed cost = $30,000

• Variable cost = $10 per unit

• Price = $50 per unit

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Break-Even Example

• Break-even volume = fixed cost/price-variable cost.

• Example:

• Given:

• Fixed cost = $30,000

• Variable cost = $10 per unit

• Price = $50 per unit

• Therefore:

• Break-even = $30,000/($50 - $10)

• Break-even = $30,000/$40

• Break-even = 750

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Pricing Strategy: The Product Life Cycle

• Introduction: Decision between skim and penetration pricing.

• Growth: Pricing used to stimulate demand, drive toward break-even point.

• Maturity: Pricing used to defend market share, retain customers, pursue profitability, and expand into additional channels.

• Decline: Pricing can be used to stimulate demand and “clear out” old products, or to “milk” existing products for profitability at end of life.

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BMGT 411 - Preparing for Week 9

• Read Chapters:

• Kottler: Chapters 13,14

• Wood: Wood Chapter 8

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