Pricing Strategy Study Guide

Pricing Strategy: Chapter 9 Study Notes

Learning Objectives

  • Identify the elements that make up a price.
  • Explain the approaches to pricing and the major factors considered in arriving at a final price.
  • Describe the demand curve, and define price elasticity of demand.
  • Explain the role of revenues (sales) and costs in pricing decisions.
  • Discuss the value of break-even analysis and conduct break-even calculations.
  • Describe the price objectives a firm may have and the constraints under which they operate.
  • Outline the four steps in determining a final price.

What is a Price?

  • Price: The money or other considerations, including other goods and services, exchanged for the ownership or use of a product.
  • Barter: The practice of exchanging goods and services for other goods and services, amounting to billions of dollars annually in domestic and international trade.

Nature and Importance of Price

  • Price serves various roles and goes by multiple names such as Tuition, Rent, Interest, Premium, Fee, Dues, Fare.
  • Marketers need to understand how pricing affects their target markets, competitors, and demand dynamics.

Price as an Indicator of Value

  • Value Pricing: A strategy that involves increasing product or service benefits while maintaining or decreasing the price.

  • Value Equation: (Value = \frac{Perceived\ Benefits}{Price})

  • As perceived benefits increase, the value perceived by consumers also increases.

Price as a Signal

  • Prices can indicate the quality of the product or service:
    • A price that is too low may signal low quality.
    • A price that is too high may give the impression of low value.
  • Setting a service price too low can cause customers to view the service as inferior.

Price in the Marketing Mix

  • Profit Equation:
    [Profit = Total\ Revenue - Total\ Cost = (Unit\ Price x Quantity\ Sold) - Total\ Cost]
  • Pricing decisions are crucial as they influence total revenue and total cost, making pricing one of the most significant decisions in marketing.

General Pricing Approaches

  • Demand-oriented Approaches:

    • Skimming
    • Penetration
    • Prestige
    • Odd-even
    • Target
    • Bundle
    • Yield management

  • Cost-oriented Approaches:

    • Standard markup
    • Cost-plus
    • Target profit
    • Target return on sales
    • Target return on investment

  • Competition-oriented Approaches:

    • Customary
    • Above, at, or below market
    • Loss leader

Demand Oriented Pricing

  1. Skimming: Setting prices high during the introductory stage of the Product Life Cycle (PLC).
  2. Penetration: Setting a lower price to attract consumers.
  3. Prestige: Setting a high price to attract status-conscious consumers.
  4. Odd-Even Pricing: Using pricing that ends in '9' to make the price seem lower.
  5. Pricing Lining: Offering multiple variations of a product at different price points.
  6. Target Pricing: Determining a price based on the expected consumer willingness to pay.
  7. Bundle Pricing: Selling multiple products or services together at a single price.
  8. Yield Management: Charging different prices based on demand, to maximize revenue.

Cost-Oriented Approaches

  • Markup Percentage:
    • Wholesalers and retailers often express markup as a percentage of the selling price.
    • Example:
    • Selling Price: $75.00
    • Cost: $60.00
    • Markup: $15.00 (20% of Selling Price).
  • Markup is always 100% when based on cost.

Profit-Oriented Approaches

  • Set targets based on specific dollar profit volumes or percentages of sales or investments.
  • These approaches rely on accurate estimates of demand for effectiveness.

Competition-Oriented Approaches

  • Focus on competitive pricing rather than purely demand, cost, or profit.
  • Example: Rolex emphasizes its high pricing to convey exclusivity and luxury.

Estimating Demand and Revenue

  • Establishing a correct price for a product is the first step in forecasting customer demand.
  • Factors influencing demand include marketing efforts, competitor actions, and overall demand estimates.

The Importance of Accurate Forecasting

  • Profit and Loss (P&L): Necessary for measuring financial performance over time, including revenues, costs, and expenditures.
  • Return on Investment (ROI):
    [ROI(\%) = \frac{Gain\ Attributed\ to\ Investment - Cost\ of\ Investment}{Cost\ of\ Investment}]

Fundamentals of Estimating Demand

  • Demand Curve: A graph showing the relationship between quantity sold and price, indicating how many units will be sold at different price points.
  • Key factors influencing demand:
    1. Consumer tastes
    2. Price of similar products
    3. Consumer incomes

Price Elasticity

  • Price Elasticity: A measure of how sensitive consumer demand and a firm's revenues are to price changes.

Fundamentals of Estimating Revenue

  • Total Revenue (TR): The overall money received from product sales defined by the equation: [TR = P \times Q] Where:
    • (P) = Unit price of the product
    • (Q) = Quantity sold.

The Importance of Controlling Costs

  • Fixed Costs (FC): Expenses that remain consistent regardless of production volume (e.g., rent, salaries).
  • Variable Costs (VC): Expenses that vary directly with production volume (e.g., materials, labor).
  • Unit Variable Cost (UVC): Variable costs expressed on a per-unit basis.
  • Total Cost (TC):
    [TC = FC + VC]

Break-Even Analysis

  • Break-even Point (BEP):
    [BEP_{Quantity} = \frac{Fixed\ Cost}{Unit\ Price - Unit\ Variable\ Cost}]

Applications of Break-Even Analysis

  • Used in marketing to study the profit impact of changes in price, fixed costs, and variable costs.
  • Tools like Excel allow for analysis of various scenarios through “what if” questions.

Identifying Pricing Objectives

  • Pricing Objectives: Clarify the role of price in business strategies. Objectives may include:
    • Long-run profit
    • Current profit levels
    • Target return
    • Market share focus
    • Volume emphasis
    • Survival
    • Social responsibility considerations.

Identifying Pricing Constraints

  • Factors limiting pricing strategies include:
    • Demand across product classes and brands
    • Product newness and its lifecycle stage
    • Production and marketing costs
    • Competitors' pricing strategies.

Legal and Ethical Considerations in Pricing

  1. Price Fixing: Collaboration between competitors to set prices.
  2. Price Discrimination: Charging different prices to different customers unfairly.
  3. Deceptive Pricing: Misleading price advertising.
  4. Predatory Pricing: Undercutting competitors to eliminate competition.

Common Deceptive Pricing Strategies

  • Bait and Switch: Offering a low price initially (the bait), then attempting to sell a more expensive product instead (the switch).
  • Conditional Bargains: Promotions like “buy one, get one free” that disguise inflated pricing.
  • Price Comparisons: Misleading advertising that suggests a comparison to a non-existent higher price.

Global Pricing Strategy

  • Dumping: Selling products abroad for less than the domestic price or costs.
  • Grey Market: Unauthorized sale outlets, varying in legality by region.

Setting a Final Price: Steps

  1. Select an approximate price level.
  2. Set the list or quoted price (including policies like one-price or flexible pricing).
  3. Make special adjustments including discounts and allowances:
    • Discounts can be quantity, seasonal, trade (functional), or cash discounts.
  4. Monitor and adjust prices according to competitor activity, legislation, and market conditions.

Review Questions

  1. Apple and pricing strategies.
  2. Fuzion Wine pricing approach.
  3. Westjet's pricing during a seat sale.
  4. A&W bundle pricing strategy.
  5. Pricing in market context for various retailers.