MARK 5320: Advanced Marketing Fundamentals
Chapter 15: Price, the Only Revenue Generator

Introduction

This module reviews the process companies must go through to effectively price their offerings, including identifying pricing objectives, accounting for the factors that affect pricing decisions and implementing a pricing strategy.

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Learning Objectives

  1. Understand the factors in the pricing framework. Explain the different pricing objectives organizations have to choose from.
  2. Understand the factors that affect a firm's pricing decisions. Understand why companies must conduct research before setting prices in international markets. Learn how to calculate the breakeven point.
  3. Understand introductory pricing strategies. Understand the different pricing approaches that businesses use.

 

Pricing

Price is the only marketing mix variable or part of the offering that generates revenue. Firms must have prices that are consistent with their products, promotions, and distribution strategies. The price, product, promotion and placement of a good or service must convey a consistent image.

The Pricing Framework

Before setting the price for an offering, a firm must determine its pricing objective or what it wants to accomplish with its pricing. It must also estimate demand, determine costs, and analyze all factors affecting pricing decisions.

The Firm's Pricing Objectives

Common pricing objectives include:

Earning a Targeted Return on Investment (ROI)

  1. ROI is the amount of profit an organization hopes to make given the amount of assets or money it has tied up in a product.  
  2. Common pricing objective.
  3. Expressed as a percentage.
  4. Example - If a company has $100,000 invested in a product, and is expecting a 10% ROI, it would want the product's profit to be $10,000.

Maximizing Profits

  1. Many companies want to increase revenues as much as possible relative to costs. To do this, they focus on lowering costs or implementing programs to encourage customer loyalty.
  2. Examples of cost-cutting measures include controlling inventory, reducing real estate holdings, cutting jobs, reducing marketing and advertising expenses, etc.
  3. Raising prices to maximize profits may work in the short-term as long as the offering is perceived to have value relative to its price.

Maximizing Sales

  1. Maximizing sales involves pricing products to generate as much revenue as possible, regardless of what it does to a firm's profits.
  2. Possible ways to maximize sales in the short-term: selling off inventory or cutting prices temporarily.
  3. Typically a short-term objective since profitability is not considered.

Maximizing Market Share

  1. By capturing a maximum amount of market share, a firm expects to earn higher profits, although that isn't always the case.
  2. Many companies feel they have to maximize market share in order to be viewed as strong competitors in their respective industries.

Maintaining the Status Quo

  1. A firm may have the objective of maintaining the status quo; meeting or equaling their competitors' prices.
  2. Airlines are good examples of industries where the members maintain the status quo.

 

Factors that Affect Pricing Decisions

This section discusses the factors affecting a firm's pricing decisions, why companies have to conduct research before setting prices in overseas markets, and how to calculate the breakeven point. In addition to identifying its pricing objective, a company must also look at the offering's costs, the demand, the customers, whose needs it is designed to meet, the external environment - such as the competition, the economy and government regulations, and other aspects of the marketing mix, such as the nature of the offering, the current stage of its product life cycle and its promotion and distribution.

Customers

Three factors relating to customers to consider when making pricing decisions include whether buyers perceived the product has value, how many buyers are in the market, and how sensitive buyers are to prices. Price elasticity is how sensitive buyers are to changes in the price of a good or service. If an offering is price elastic, then raising the price willguess-brand.jpg cause buyers to purchase less of the offering. If an offering is price inelastic, then raising the price will not affect the buyer's purchasing decision in the short term.   However, companies do not have free rein to raise prices for offerings with an inelastic demand. Eventually, customers may find alternative offerings, rather than continue to purchase the product or service long-term. Luxury goods are viewed as having an elastic demand because increases in price result in fewer sales or less demand. Necessities are viewed as having an inelastic demand, meaning sales will not decrease significantly with the increases in price. The line between luxury and necessity goods can vary from buyer to buyer. For example, smokers keep purchasing cigarettes even after prices rise significantly, but most people would agree that cigarettes are not necessities.

  

 

Luxury

10 Most Expensive Clothing Brands

 

Competitors

Because companies want to establish and maintain loyal customers, they will often match their competitors' prices. Some give discounts if lower prices are found elsewhere. The availability of close substitutes also affects a company's pricing decisions.

The Economy and Government Laws and Regulations

  1. During weak economies, companies generally lower their prices.
  2. Pricing decisions are also affected by federal and state regulations.
    1. Robinson-Patman Act limits a seller's ability to charge different customers different prices for the same product. The intent of the act is to protect small businesses from larger business that try to extract special discounts and deals for themselves in order to eliminate their competition.  
    2. Cost differences, market conditions, and competitive pricing by other suppliers can justify price differences in some situations. Price discrimination such as offering senior citizens discounts at restaurants or charging children discounted prices at the movies is legal.
    3. Price fixing is a form of collusion whereby two or more companies in an industry get together and agree to set their prices at a certain level. Price fixing is not uncommon. Companies caught price fixing include Nintendo, Sharp, LG, Virgin Atlantic Airways, American Airlines, and British Airways.
    4. Unfair trade laws keeping a minimum price level for products protects smaller businesses.   When companies act in a predatory manner by setting low prices to drive competitors out of business, it is a predatory pricing strategy.
    5. Bait and switch schemes involve using a "too good to be true" deal on a product to attract customers into the store, then attempting to sell them a more expensive product. While bait-and-switch pricing is illegal in many states, stores can add disclaimers to their ads stating that there are no rain checks or that limited quantities are available to justify trying to get customers to buy different products.

 

Product Costs

The costs of the product—its inputs—including the amount spent on product development, testing and packaging required has to be taken into account when a pricing decisions is made. So do the costs related to promotion and distribution. Companies have to consider the breakeven point for offerings when making pricing decisions. Breakeven is  where total costs = total revenue. Ideally, a company wants a product that generates revenue that exceeds its costs, but this doesn't always happen, especially with new offerings.

Breakeven

Pricing Strategies

After establishing pricing objectives and analyzing factors affecting pricing decisions, a company must then determine what pricing strategy it will follow. A company may follow different pricing strategies for different products based on where the product is in its life cycle. Introductory pricing strategies are used for new products, while different approaches are used for more mature products.

Introductory Pricing Strategies

 

Pricing Approaches

  1. Cost-plus pricing - retailers take the cost of the product for them and then add a profit to determine a price. Also known as mark-up pricing. This practice is very common. Companies should take into consideration eventual mark downs or sales on the product when figuring the mark-up amount.
  2. Odd-even pricing occurs when a company prices a product a few cents or a few dollars below the next dollar amount. For example, instead of $10, the price is $9.99.  
  3. Prestige pricing occurs when a higher price is utilized to give an offering a high-quality image. The same product may be priced differently at two different stores because one store has a higher perceived image.  
  4. Price lining or having few price levels but many products available at those levels is another strategy. Examples of products with this type of pricing are neckties and DVDs.
  5. Demand-backward pricing is where companies start with the price demanded by consumers and then create offerings at that price. Around the holidays, retailers will often have displays of products that all have the same price.
  6. Leader pricing involves pricing one or more items low to get people in the store and then buying other items.  
  7. Sealed bid pricing is the process of offering to buy or sell products at prices designated in sealed bids.  
  8. Online auctions allow buyers to bid and negotiate prices for posted products from sellers. Buyers can also post a "want" item called a forward auction and what they are willing to pay for it, called a reverse auction.
  9. Going rate pricing occurs when buyers pay the same price regardless of where they buy the product or from whom. These products are usually commodities such as wheat, gold, silver, etc.  
  10. Price bundling occurs when different offerings are sold together at a price that's typically lower than the total price a customer would be paying by buying each offering separately. Popular examples of price bundling are value meals at fast food restaurants.
  11. Captive pricing is strategy firms use when consumers must buy a given product because they are at a certain event or location or they need a particular product because no substitutes will work. Concessions at sporting events or a movie are one example. Another example is razors and razor blades.
  12. Product mix pricing is pricing products consumers use together with different profit margins. Razors and razor blades are also an example of product mix pricing.  
  13. Two-part pricing means there are two different charges customers pay for an offering. An example would be cell phones. There is an initial monthly charge and then additional charges if the customer exceeds a set minute allowance.
  14. Payment pricing is when customers are allowed to spread out the purchase price over several payments, usually on a credit card.
  15. Price discrimination is where certain groups of customers are charged different prices than others.  
  16. Promotional pricing is a short-term tactic designed to get people into a store or to purchase more of a product.   Sales are examples of this type of pricing approach.

Price Adjustments

Organizations have to decide what policies they will have with regard to changing the listed prices for their products, known as making price adjustments. Common price adjustments include:

  1. Quantity discounts.
  2. Shipping discounts and risk of loss.
  3. Uniform-delivered pricing, which means buyers pay same shipping charges regardless of where they are located.
  4. Reciprocal agreements are agreements where merchants agree to promote each other to customers by offering discounts.
  5. Bounceback promotions are where retailers give customers coupons, rebates, etc to use on their next purchases.