Pricing Strategies and Concepts

Pricing

What is Price?

• Price is what you pay for something, or the value exchanged for the benefits of having or using a product/service. This includes:
  • Time
  • Psychological costs
  • Other resources
• Value is determined by: Value = Benefits - Costs
  • Benefits encompass service, brand, and product benefits.
  • Costs include price and other costs.

Factors Affecting Pricing Decisions: Internal

1. Marketing Objectives
   • Maximize profit
   • Gain market share
   • Infer a level of quality
   • Survive
2. Marketing Mix Strategy
   • Price needs to be consistent with the other 3 P's (Product, Promotion, and Place) and reflect advertising efforts.
3. Costs
   • Costs affect profit, so setting the optimal price is crucial.

Factors Affecting Pricing Decisions: External

1. Demand for Your Product
2. Competition
   • Competitor’s prices
   • Strength of competition
3. Economy
   • Cost of components (natural resources)
   • Economic conditions

Price Elasticity

• Price elasticity tells us how much the demand for a product will change with a change in price.
• Formula: e = \frac{\% \text{ CHANGE IN QUANTITY DEMANDED OF GOOD “A”}}{\% \text{ CHANGE IN PRICE OF GOOD “A”}}

Price Elasticity: Types

• Elastic: Consumers buy more or less of a product when the price changes.
• Inelastic: An increase or decrease in price will not significantly affect demand.
• Unitary Elasticity: An increase in sales exactly offsets a decrease in prices, and revenue is unchanged.

Price Elasticity: Elastic Demand

• If demand greatly changes with a price change, demand is elastic.
• Products that are price-sensitive and have many substitutes.
• A relatively small decrease in price results in a substantial increase in quantity demanded.
• E > 1.0

Price Elasticity: Inelastic Demand

• If demand hardly changes with a price change, demand is inelastic.
• Products that are less price-sensitive and have few substitutes.
• A relatively large increase in price results in only a small decrease in quantity demanded.
• E < 1.0

Price Elasticity: Price, Quantity, and Revenue

Stages for Establishing Prices

1. Develop pricing objectives
2. Assess target market’s evaluation of price
3. Evaluate competitors’ prices
4. Select a basis for pricing
5. Select a pricing strategy
6. Determine a specific price

Develop Pricing Objectives

• Profit: Identify price and cost levels that allow the firm to maximize profit per product.
• Status Quo: Identify price levels similar to competitor average price.
• Market Share: Adjust price levels so that the firm can maintain or increase sales relative to competitors’ sales.

Assessing the Target Market’s Evaluation of Price

• Importance of price depends on:
  • Type of product
  • Type of target market
  • Purchase situation

Evaluating Competitors’ Prices

• Sources of Competitors’ Pricing Information
  • Comparative shoppers
• Importance of Knowing Competitors’ Prices
  • Helps determine how important price will be to customers
  • Helps marketers in setting competitive prices for their products
• Customer View of Pricing and Marketing
  • Pricing above competition
  • Pricing below competition

Selecting a Basis for Pricing

• Cost
• Demand
• Competition
• New Product

Selecting a Basis for Pricing: Cost

• Cost-plus pricing: Adding a specified dollar amount to the seller’s costs.
  • Markup: Adding to the price of the product a predetermined percentage of the variable cost.
  • Margin: Adding to the price of the product a predetermined percentage of the total price.

Cost-Based Pricing

• Profit = Revenue - Costs
• Revenue = Price x units sold
• Costs = Fixed Costs + Variable Costs

Cost-Based Pricing: Markup Pricing

• Setting price where price = markup + cost
• Markup on selling price = \frac{(\text{selling price - cost})}{\text{selling price}}
• Cost = (1 - \text{markup on selling price}) \times (\text{selling price})
• Selling price = \frac{\text{cost}}{(1 - \text{markup on selling price})}
• Selling Price = Cost + Markup
• Cost % + Markup % = 100 %

Example 1

• Selling Price = $1000
• Cost = $700
• Markup = 30%

Example 2

• Cost = $100
• Markup = 50%
• Selling Price = $200

Example 3

• Selling Price = $300
• Cost = $100
• Markup = 66.7%

Cost-Based Pricing: Break-Even Pricing

• Break-Even Quantity = \frac{\text{Total Fixed Costs}}{\text{Selling Price - Variable Cost}}
• The break-even point is where a company produces the same amount of revenues as expenses.

Example

• Fixed cost (FC) = $15,000
• Selling Price (SP) = $2.00
• Variable cost per unit (VC) = $.50
• Fixed cost contribution = $1.50
• Break even point in units = \frac{FC}{(SP - VC)} = 10,000 units
• Break even point in dollars = BEP units * SP = $20,000

Selecting a Basis for Pricing: Demand

• Demand-Based Pricing: Customers pay a higher price when demand for the product is strong and a lower price when demand is weak.
• Also known as Flexible or Variable pricing
  • Off-peak cheaper prices
  • Different segments pay different rates

Selecting a Basis for Pricing: Competition

• Competition-Based Pricing: Pricing influenced primarily by competitors’ prices
• Method importance increases when:
  • Competing products are homogeneous resulting in elastic demand
  • Organization is serving markets in which price is a key consideration

Selecting a Basis for Pricing: New Product

• Price Skimming
  • Charging the highest possible price that buyers who desire the product will pay
• Penetration Pricing
  • Setting prices below those of competing brands to penetrate a market and gain a significant market share quickly

New Product Pricing Strategies

• Skimming
• Penetration

Pricing Strategies

• Everyday Low Prices
  • Setting a low price for products on a consistent basis
• Reference Pricing
  • Pricing a product at a moderate level and positioning it next to a more expensive model or brand
  • Retailers sometimes add higher priced items to extend the range of product price alternatives
  • Known as selling against the brand
• Portfolio Pricing
  • Different levels of price points across a product category where consumers are willing to pay more for extras
• Bundle Pricing
  • Packaging together two or more complementary products and selling them for a single price
• Multiple-Unit Pricing
  • Packaging together two or more identical products and selling them for a single price
• Odd-Even Pricing
  • Ending the price with certain numbers to influence buyers' perceptions of the price or product
• Captive-Product Pricing
  • Captive products are items designed specifically for use with another product
  • Many captive products are necessary to the function of the core product
• Single-Price
  • All customers are charged the same price for all the goods and services offered for sale within that product category
• Bait Pricing
  • Illegal practice of advertising unrealistically low prices to bring customers into the store
• Leader Pricing
  • Also known as loss leader pricing, products priced below the usual markup, near cost, or below cost

Determining a Specific Price

1. Competition
2. Distribution strategy
3. Promotion strategy
4. The relationship of price to quality
5. Substitutes
6. Complements