Pricing Concepts

Pricing ConceptsStrategic Marketing

Pricing

• Warmup:

• Of the 4 P’s where do you rank the Price Factor in terms of importance?

Learning Objective #1: Importance of PriceDiscuss the importance of pricing decisions to the economy and to the individual firm

To the consumer...Price is the cost

of something

To the seller...Price is revenue

Price allocates resources in a free-market economy

L.O. #1: Importance of Price

• Price is that which is given up in an exchange to acquire a good or service.• Money• Products• Time lost waiting in line

• Consumers are interested in obtaining a reasonable price• Reasonable price = Perceived reasonable value

L.O. #1: Importance of Price

• Revenue: The price charged to customers multiplied by the number of units sold.• Revenue is what pays for every aspect of a company• Covers fixed and variable costs

• Profit is what is left over from revenue once all bills are paid• Profit = Revenue minus expenses• Profit is what drives growth, salary increases, & corporate

investment

L.O. #1: Importance of Price

• There are several trends that are influencing price• Flood of new products. Consumers have more choices.

• Increased availability of bargain-priced private and generic brands• Price cutting as a strategy to maintain or regain market share.

Competitors are using low price strategies

• Internet used for comparison shopping

• Buyers are more price sensitive & better informed

Learning Objective #2: Pricing Objectives

There are three pricing objectives:1. Profit-Oriented2. Sales-Oriented3. Status Quo

Learning Objective #2: Pricing Objectives• Profit-Oriented Pricing Objectives

• Profit Maximization• Set prices so that the total revenue is as large as possible relative to total costs• Doesn’t always mean that a product is priced unreasonably• If product is in a competitive marketplace, price will be more competitive• Product will not be priced higher than perceived value• Can be accomplished by

• Option A: Increasing customer satisfaction (Better option)• Option B: Reduce costs with more efficient operation

Learning Objective #2: Pricing Oriented Obj.• Satisfactory Profits: Reasonable level of profits

• Riskier industry = Higher Profit Percentages• Less Risky Industry = Lower Profit Percentages• Takes into account what a business owner is willing to do

• Doesn’t want to work weekends & assumes less profits

• Target Return on Investment: • Most common Profit-Oriented Pricing Objectives• Measures overall effectiveness in generating profits with the available assets• Higher ROI, the better off the company is• Many companies use this model: GM, Dupont, ExxonMobile, etc..• Most firms aim to be in the 10% - 30% ROI range• Companies can base their targeted ROI off of industry standards

Learning Objective #2: Pricing Objectives• ROI = Net profit after taxes divided by total assets.

ROI = Net Profit after taxes Total assets

Assume that Johnson & Johnson had assets of $4.5 million & net profits of $550,000 and a target return on

investment of 10%. Did they meet their target?

550,000 / 4,500,000 = 12.2%.

L.O. #2: Sales-Oriented Pricing Objective• Sales oriented pricing objectives are based either on • Market share: A company’s product sales as a percentage of total sales for that industry.

• Sales can be in dollars or in units of product• Revenue is most common method of determining market share• Possible to be leader in market share and not be successful

• How could a company sell more units of a product yet not lead the industry in revenue?

• Sales Maximization• Short-term objective to maximize sales• Ignores profits, competition, and the marketing environment• Usually occurs when a company needs revenue quickly or is in an uncertain market• May be used to sell off excess inventory• Not a long-term pricing model

L.O. #2: Status Quo Pricing Objective

• Status Quo Pricing seeks to maintain existing prices &/or meet the competitions prices • Advantageous because it requires little planning• Base prices off of industry leaders• Passive approach• Many competitors of Walmart will visit their store

weekly to ensure their prices are competitive

Learning Objective #3: Demand Determinant

Explain the role of demand in price determination • Two factors affecting price:

• Demand• Cost to the seller for that good or service

• When pricing goals are mainly sales oriented; demand considerations usually dominate

Learning Objective #3: Demand Determinant• Demand: The quantity of a product that will be sold in the

market at various prices for a specified period.• Quantity people buy depends on price• Higher the price; less of a demand• Lower the price; higher the demand• Demand curve slopes downward and to the right• If production is increased; price must be decreased• Lower prices will attract new customers

Learning Objective #3: Demand Determinant• Supply: The quantity of a product that will be offered to the

market by a supplier at various prices for a specific period.• Supply curve slopes upward and to the right

• Output tends to increase at higher prices because manufacturers can sell more

• If consumers agree to price increase, production is enhanced

• Price increases = Supply Increases

Learning Objective #3: Demand Determinant• The demand curve alone cannot predict consumption• The supply curve alone cannot predict production• Key is when supply & demand interact• P. 544

• Surplus: When supply exceeds demand. Pushes price down.

• Shortage: When demand exceeds supply. Pushes price up.

• Price Equilibrium: The price at which demand and supply are equal

Learning Objective #3: Demand Determinant• Elasticity of Demand: Consumers’ responsiveness or sensitivity to

changes in price.

• Elastic Demand occurs when people buy more or less of a product when the price changes.

• Inelastic Demand means that a change in price will not significantly impact on demand

• Unitary Demand means that an increase in sales exactly offsets a decrease in prices, so total revenue remains the same

Price Goes... Revenue Goes... Demand is...

Down Up Elastic

Down Down Inelastic

Up Up Inelastic

Up Down Elastic

Up or Down Stays the Same Unitary Elasticity

Measuring Elasticity of Demand

Learning Objective #3: Demand Determinant• Factors that affect Elasticity of Demand• Availability of substitutes• Price relative to purchasing power• Product durability• A products other uses• Rate of inflation

Learning Objective #4: Yield Management Systems (YMS)• Yield Management system (YMS): A technique for adjusting prices that

uses complex mathematical software to profitably fill unused capacity.• Developed in airline industry but is now used in lodging, rental car companies,

hospitals, & other transportation industries

• Involves discounting prices & limiting early sales at discounted prices

• Overbook capacity

• Used in industry where products are perishable• If left unused the opportunity for revenue is lost forever• Example: Airplane seat & Hotel room• Manufacturing plants that are under utilized can produce perishable goods • All-State Insurance went from 3 pricing categories to 1,500

L.O. #4: Yield Management Systems

• http://www.hulu.com/watch/46550

• 59:25 – 51:22 minute mark

Learning Objective #5: Cost Detriment

• Sometimes a company will base its pricing on costs rather than demand

Two Types of Costs• Variable Costs: Varies with changes in level of output

• Example: Cost of materials

• Fixed Costs: Does not change as level of output changes• Example: Rent & Salaries

L.O. #5: Cost Detriment of Price• Markup Pricing

• The most popular used by wholesalers & retailers to set a selling price

• Uses the cost of buying the product from the producer, plus amounts for profit & for expenses not otherwise accounted for.

• Example: A Retailer will add a certain percentage to the cost of the merchandise received to arrive at the retail price.

• Item costs $1.80 and is sold for $2.20 has a markup of $.40 or 22% of cost ($.40 / $1.80)

• Retailers tend to use the percentage figure to explain markup (e.g. 22%)

• Gross margin is difference in cost of product from selling price $.40

L.O. #5: Markup Pricing

Markup Pricing Formula/ExampleRetail Price = Cost

1.0 – Desired return on sales (%)

If the retailer wants a 30% return then:Retail Price = $1.80

1.00 - .30

Retail Price = $2.57

L.O. #5: Keystoning

Keystoning• Markups are often based on experience

• Small retailers mark up merchandise 100 percent over cost • Doubling the cost

• Retailers tend to avoid a “set” markup because of promotions and seasonal items

L.O. #5: Break-Even Pricing

Break Even AnalysisDetermines what sales volume must

be reached before the company breaks even & no profits are earned.

Break-even point is wheretotal revenue = total costs

Break-even Qty = Total fixed costs Fixed cost contribution

L.O. #5 Break Even Examples

• Typical Break Even Analysis will have a consistent fixed costs & a constant average variable cost.

• Example:• Price per unit: $15.00• Variable cost per unit: $7.00• Total fixed cost: $9,000

$9,000 / ($15.00 - $7.00) = 1,125 units

L.O. #6: Other Determinants of Price

• Other factors besides cost & demand can affect price• Stages in the life cycle• Competition• Product distribution strategy• Promotion Strategy• Internet• Perception of quality

L.O. #6: Product Life Cycle Effect

L.O. #6: Competition

• High prices may induce firms to enter the market

• Competition can lead to price wars• Increased competition leads to lower prices• Decreased competition leads to higher prices

• Global competition may force firms to lower prices

L.O. #6: Distribution

• Consumer may pay more if product is sold in a convenient location

• Provide sellers with a larger trade allowance to encourage sales

• Selling against the brand: Stocking well known items as high prices in order to sell store brands at discounted rates.

• Gray Marketing Goods are goods sold outside traditional distribution channels• Retailers obtain goods at lower prices & sell them cheaper to consumers• Manufacturers may not honor warranties on these items

L.O. #6: Internet

• The internet allows consumers to compare prices easier

• Companies are able to track consumer habits & preferences

• Shopping Bots: Online robots that search the internet for the best deal. • Retailers can pay to more to be at the top of the search

• Internet Auctions: Sites like eBay & Amazon that offer user generates items• Susceptible to fraud

LO #6: Relationship of Price to Quality

• Consumers tend to rely on a high price as a predictor of good quality.

• Prestige Pricing is charging a high price to help promote a high quality image• A successful prestige pricing strategy requires a retail price that is

reasonably consistent with consumers’ expectations

Setting the Right PriceStrategic Marketing

L.O. #1: Choose a Price Strategy

• 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.

• Price Skimming: A firm charges a high introductory price, often coupled with heavy promotion.

• Penetration Pricing: A firm charges a relatively low price for a product initially as a way to reach the mass market

L.O. #1: Pricing Strategies

• Price Skimming is used when you have • Inelastic demand

• Unique Advantages/Superior

• Legal Protection of Product

• Technological Breakthrough

• Blocked Entry to Competitors