CHAPTER 11 NOTES PRICING

Influences on Pricing Decisions

Demand
Supply
Environmental


1. Demand Influences on Pricing Decisions
Demand influences on pricing decisions concern primarily the nature of the target
market and expected reaction of consumers to a given price or change in price. The
three primary considerations here are:

1.1. Demographic Factors
Demographic factors that are particularly important for pricing decisions
include the following:
1. Number of potential buyers, their ages, education and gender.
2. Expected consumption rate of potential buyers.
3. Economic strength of potential buyers.


1.2. Psychological Factors
Psychological factors related to pricing concern primarily how consumers will
perceive various prices or price changes.

Examples of psychological pricing include prestige pricing and odd-even
pricing (discussed later).

Price discounting is also psychological. Consumers
feel more pressure to buy an item when it is on sale because they dont
want to pass up on a deal.

1.3. Price Elasticity
Price elasticity is a measure of price sensitivity
Elasticity is estimated by dividing relative changes in the quantity demanded
by the relative changes in price.





Technically classified, over 1 = elastic demand, under 1 = inelastic demand


Staple goods or necessities for which there is not a close substitute are highly
inelastic (ex., gasoline, heating fuels, etc). Of course, individual factors play a
role, for example Diet Coke may be inelastic demand for a loyal user but not
for others. Luxury items, non-necessities, or items for which there are close
substitutes are considered highly elastic (Ex., jewelry, cruises, etc).

1. Elasticity can be estimated from historical data or from other
price/quantity data.
2. Sampling a group of consumers from the target market and polling them
concerning various price/quantity relationships can estimate price
elasticity.

The option to postpone a purchase also influences elasticity. If you have a
time constraint you are less likely to be price sensitive. Also, price versus
income is a determinant of elasticity. For example, for a minor purchase
(relative to your income) a price change will not alter demand that much.

Cross elasticity of demand Refers to the degree to which the quantity of
one products demand will increase or decrease in response to the change
in the price of another product. Substitutes and complementary products
have high cross elasticities (Ex., coffee / tea.. Large SUVs / gasoline).


2. Supply Influences on Pricing Decisions
The factors that relate to the supply influences on pricing decisions are costs, and the
nature of the product.

2.1. Cost Considerations in Pricing
The price of a product usually must cover costs of production, promotion, and
distribution. Cost oriented pricing is a common approach.

Three common cost-oriented pricing variations include:
1. Rate-of-return pricing is based on the goal of achieving a specific return
on investment.

2. Cost-plus pricing usually entails a firm charging a set dollar amount above
costs. This would be common for a service business that had some hard
costs and a fee is charged for the services provided.

3. Mark-up pricing is a percentage above costs (the margin). While many
firms use a standard percentage mark-up, for others the mark-up depends
on the type of product. The mark-up percentage also varies with the type
of store. High volume retailers (such as supermarkets) have smaller mark-
ups, while jewelers have high mark-ups.





Usually mark-ups get higher at each stage in the distribution channel. Larger
mark-ups later in the channel reflect that as the product gets closer to the ultimate
consumer the volume gets lower. Retailers usually have the highest mark-up as
they provide the most services to the consumer.


2.2. Product Considerations in Pricing
Three important characteristics that affect pricing are:

2.2.1. Perishability
Goods that are very perishable in a physical sense have more fluid
pricing. Perishability concerns most directly apply to services (hotels,
airlines, golf courses, etc.). Any service business must price
strategically to try to maximize usage and avoid unused capacity. For
example off-peak pricing is common fro service businesses.

2.2.2. Distinctiveness
Products can be classified in terms of how distinctive or differentiated
they are.

Few consumer goods are perfectly homogeneous, the more distinctive
marketers can make their products the more pricing power they will
have. For example, there is little pricing power in bottled water,
however companies that market uniquely flavored water will be able to
command higher margins.

2.2.3. Life Cycle
The stage of the life cycle that the product is in can have important
pricing implications.
In the later stages of the life cycle less pricing variability among
competitors exists.

In the introductory phase of the life cycle firms generally either adopt a
skimming or penetration strategy.
.
Skimming strategy - The seller charges a relatively high price on a
new product. The goal is to capture margins early. This is often used
to recoup R&D costs and to exploit the presence of early adopters.

An effective strategy when:
- Demand is sufficient to warrant a high price
- None or few competitors
- High initial price will not attract competitors


- Lowering price will have little effect on increasing the sales volume
- Customers interpret the high price as indicating high quality


Penetration strategy - The seller charges a relatively low price on a
new product.

An effective strategy when:
- The goal is to capture market share early.
- You seek to establish your brand as the pioneer in the market
- Many segments of the market are price sensitive
- A low price will dissuade competitors from entering the market.
- Unit costs will decrease as product volume increases



3. Environmental Influences on Pricing Decisions
Environmental influences on pricing, includes variables that are uncontrollable by the
marketing manager. Two of the most important of these are competition and
regulations.

3.1. Competition
Consideration must be given to such factors as:
1. Number of Competitors.
2. Size and strength of competitors.
3. Likely entry of new firms into the market
4. Degree of vertical integration of competitors (impacts costs control)
5. Cost structure of competitors.
6. Historical reaction of competitors to price change.
7. Similarity of competitors products (are they close substitutes?)


3.2. Government Regulations
Prices of certain goods and services are regulated by state and federal
government. Legal constraints on pricing exist.

1. Price fixing is illegal. Sellers must not make any agreements with their
competitors to collectively control the price of goods.

2. Deceptive pricing practices are outlawed under section 5 of the federal
trade commission law.







4. General Pricing Model
Effective pricing involves the consideration of many factors and different industries
may have varied pricing practices. However, a general model would generally contain
the following:


4.1. Set Pricing Objectives
The pricing process should begin with stating the pricing objective. For
example, pricing with the goal to maximize short-term profits will be different
than a pricing strategy where the goal is to maximize market share.



4.2. Evaluate Product-Price Relationship
Any pricing model should ensure value to the consumer. There are three
basic value positions.

1. A product could be priced relatively high for a product class but should
offer value in the form of high quality, special features, or prestige.

2. A product could be priced at about average for the product class but
should offer value in the form of good quality for a reasonable price.

3. A product could be priced relatively low for a product class but should
offer value by providing acceptable quality for the price.

In assessing the value proposition of their products a firm must always
consider the price/quality relationship for competitive offerings in that market.


4.3. Estimate Costs and Other Price Limitations
The costs to produce and market products provides a lower bound for pricing
decision. Both direct and indirect costs should be considered.

Efforts to minimize production costs should be an ongoing concern for any
firm.

Competitors offerings of similar and substitute products will always limit
pricing power.







4.4. Analyze Profit Potential
The analysis resulting from the preceding stages should result in a range of
prices that could be charged. Profit potential in conjunction with all other
goals and considerations must guide decision-making.


4.5. Set Initial Price Structure
Once all supply, demand, and environmental factors have been considered, a
marketer will be in a position to determine an initial pricing model.

When marketers consider their pricing strategy they must consult with the
other functional areas of the firm (finance, operations, etc.) to ensure support
for the pricing plan.


4.6. Change Price as Needed
The firm must continuously monitor its costs structure and the environment in
order to assess if a price alteration is in order.

Price is the most easily changed element of the marketing mix. However, a
price alteration should only be done after careful consider of the ramifications
of a change.


PRICE CHANGES
Firms should consider cutting prices when:
They have excess capacity
Their market share is falling
The costs are lower with greater production volume

Firms should consider raising prices when:
Costs are increasing
There is over-demand for the product


If at possible, refrain from cutting prices and look to increase customer value in some way.

*Insights from McKinseys study regarding pricing and Standard and Poors 1,000:

A 3% price cut leads to:
Reduction in profits by 37% (8.1% to 5.1%)
Or
A need to increase sales by 12%

In many cases a change in price will not stimulate demand enough to justify the loss of margins.




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Pricing Tactics

Product Line Pricing Pricing products in the line at various price points based on features (ex.,
$25, $45, and $65 ties). This allows you to serve many segments.

Or

Line Pricing A different brand for different product levels (Ex., Busch beer and Bud)

Price Bundling Package deals (Ex., computer & printer; airfare, hotel & car). Bundling is an
opportunity for firms to work together for cross-selling purposes. It is also a strategy some firms
use to move slower products. Consumers are generally receptive as it may offer convenience
and reduce decision-making. In addition in many cases consumers perceive the bundle to
represent a deal.

Complementary pricing The pricing strategy is an attempt to capitalize on the opportunity for
maximizing long-term revenue by sacrificing the margin on one product in order to promote the
sales of another complementary product (ex., printers and ink cartridges; razors and blades cell
phone and phone service).

Everyday Low Pricing.Hello Wal-MartEDLP is generally only possible for large chains.

Periodic discounting Peak and off-peak pricingalso inconsistent sales used by retailers
(high low pricing). Ideally it captures both the non-price sensitive and the price sensitive
markets.

Image / Prestige Pricing Positioning is driven by the high price point prices are set high to
convey image or quality or status

Loss-leader pricing Deliberately setting a price below a customary price to attract customers in
hopes they will buy other products as well (Ex., significantly discounting turkeys at
Thanksgiving is done to attract shoppers).

Odd-even pricing Setting a price a few dollars or cents under an even number (ex, $9.95 or
$9.99). Companies do it because it works! Some believe that people only really process the first
number and pay less attention to others. Another theory is that when prices end in a 9
consumers perceive the product to be on sale.

Predatory pricing Charging a very low price for a product with the intent of driving
competitors out of business. Firms cannot charge below their costs in order to drive out
competition. It is illegal to do so as it is speculated that once the firm drives out their competitor
they will increase prices.




Consumer Considerations

For the consumer the perceived value must be greater than the price otherwise.NO
SALE!

Mangers must understand what value consumers place on the benefits they receive from the
product. This includes the tangible and intangible aspects of the product. For example when
going out to dinner at a nice restaurant, the value is not just in the food but the service,
atmosphere, and the environment.



Reference Prices influence the perceived fairness of a price for consumers. Reference prices
may be internal or external.

Internal
Sources: Price last paid, price usually paid, competitors prices
Note: continuous deals of putting a product on sale stands to reframe internal
prices

External
Usually a posted regular retail price (ex. Sticker price for a car), this reframes
the value for the consumer.


Price/Quality inferences do existin particular when the consumer finds it too difficult or time
consuming to carefully assess quality. The price / quality inference is also common for
consumers when they are unfamiliar with the product class and the attributes that are truly
important for that type of product.