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−CostsValue = 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=% CHANGE IN QUANTITY DEMANDED OF GOOD “A”% CHANGE IN PRICE OF GOOD “A”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

Demand is…Price goes…Revenue goes…
ElasticUpDown
ElasticDownUp
InelasticUpUp
InelasticDownDown
Unitary ElasticityUp or downStays the same

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 = (selling price - cost)selling price\frac{(\text{selling price - cost})}{\text{selling price}}
  • Cost = (1−markup on selling price)×(selling price)(1 - \text{markup on selling price}) \times (\text{selling price})
  • Selling price = cost(1−markup on 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 = Total Fixed CostsSelling Price - Variable Cost\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 = FC(SP−VC)\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

Higher QualityLower Quality
Higher PricePremium StrategyOvercharging Strategy
Lower PriceGood-Value StrategyEconomic Strategy
  • 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