Pricing Strategy Notes

Pricing Strategy: Understanding and Capturing Customer Value

Pricing Concepts

Price Definition:
- Price is the amount of money charged for a product or service.
- It represents the sum of all values consumers exchange to gain the benefits of having or using the product or service.
- Price is the only marketing mix element that generates revenue; all others incur costs.

Customer Perceptions of Value

Value Perception:
- Pricing should consider how much value consumers place on the benefits they receive from the product.
- The price should effectively capture that perceived value.
Value-Based Pricing:
- Uses the buyers’ perceptions of value as the key to pricing, not the seller's cost.
- Price decisions are made before the marketing program is developed (customer-driven).
Cost-Based Pricing:
- Driven by the product and its associated costs.
Good-Value Pricing:
- Offers the right combination of quality and good service at a fair price.
- Existing brands are often redesigned to provide more quality for a given price or maintain the same quality at a reduced price.
Everyday Low Pricing (EDLP):
- Involves charging a constant, low price with few or no temporary price discounts.
High-Low Pricing:
- Involves charging higher prices on an everyday basis but with frequent promotions to temporarily lower prices on selected items.
Value-Added Pricing:
- Attaches value-added features and services to differentiate offers.
- Supports higher prices and builds pricing power.
Cost-Based Pricing:
- Sets prices based on the costs of production, distribution, and selling the product, plus a fair rate of return for effort and risk.

Company and Product Costs

Types of Costs:
- Fixed Costs
- Variable Costs
- Total Costs
Fixed Costs:
- Costs that do not vary with production or sales level.
- Examples: Rent, depreciation, interest payments, insurance, executive salaries.
Variable Costs:
- Costs that vary with the level of production.
- Examples: Utilities, raw materials, wages, sales commissions.
Total Costs:
- The sum of fixed and variable costs for any given level of production.
Average Cost:
- The cost associated with a given level of output.

Cost-Plus Pricing

Definition:
- Adding a standard markup to the cost of the product.
Benefits:
- Sellers are certain about costs.
- Prices are similar in the industry, minimizing price competition.
- Consumers perceive it as fair.
Disadvantages:
- Ignores demand and competitor prices.

Break-Even Analysis and Target Profit Pricing

Break-Even Pricing:
- The price at which total costs equal total revenue, resulting in no profit.
Target Profit Pricing:
- The price at which the firm will break even or achieve its target profit.

Other Internal and External Considerations

Customer perceptions of value set the upper limit for prices, while costs set the lower limit.
Companies must consider both internal and external factors when setting prices.
Target Costing:
- Starts with an ideal selling price based on consumer value and then targets costs to ensure that the price is met.
Organizational Considerations:
- Who should set the price?
- Who can influence the prices?

The Market and Demand

Understanding the relationship between price and demand is crucial.
Types of Markets:
- Pure competition
- Monopolistic competition
- Oligopolistic competition
- Pure monopoly
Demand Curve:
- Shows the number of units the market will buy in a given period at different prices.
- Normally, demand and price are inversely related (Higher price = lower demand).
- For prestige (luxury) goods, higher price can equal higher demand if consumers perceive higher prices as higher quality.
Price Elasticity of Demand:
- Illustrates the responsiveness of demand to a change in price.
  - Price\ elasticity\ of\ demand = arc{\%\ change\ in\ quantity\ demand}{\%\ change\ in\ price}
- Inelastic Demand:
  - Demand hardly changes when there is a small change in price.
- Elastic Demand:
  - Demand changes greatly for a small change in price.

Competitor's Strategies

Comparison of offerings in terms of customer value.
Strength of competitors.
Competition's pricing strategies.
Customer price sensitivity.

Other External Considerations

Economic conditions
Reseller's response to price
Government regulations
Social concerns

Pricing Strategies

Market-skimming pricing
Market-penetration pricing

New-Product Pricing Strategies

Market-Skimming Pricing:
- A strategy with high initial prices to “skim” revenue layers from the market.
- Conditions for Effective Skimming:
  - Product quality and image must support the price.
  - Buyers must want the product at the price.
  - Costs of producing the product in small volume should not negate the advantage of higher prices.
  - Competitors should not be able to enter the market easily.
Market-Penetration Pricing:
- Sets a low initial price to penetrate the market quickly and deeply to attract a large number of buyers and gain market share.
- Conditions Favoring Penetration Pricing:
  - Price-sensitive market.
  - Inverse relationship between production and distribution cost and sales growth.
  - Low prices must deter competition.

Product Mix Pricing Strategies

Product line pricing
Optional-product pricing
Captive-product pricing
Two-Part pricing
By-product pricing
Product bundle pricing
Product Line Pricing:
- Considers the cost differences between products in the line, customer evaluation of features, and competitors’ prices.
Optional Product Pricing:
- Takes into account optional or accessory products along with the main product.
Captive-Product Pricing:
- Involves products that must be used along with the main product.
Two-Part Pricing:
- Breaks the price into:
  - Fixed fee
  - Variable usage fee
By-Product Pricing:
- Refers to products with little or no value produced as a result of the main product.
- Producers seek little or no profit other than to cover storage and delivery costs.
Product Bundle Pricing:
- Combines several products at a reduced price.

Price-Adjustment Strategies

Discount and allowance pricing
Segmented pricing
Psychological pricing
Promotional pricing
Geographic pricing
Dynamic pricing
International pricing
Discount and Allowance Pricing:
- Reduces prices to reward customer responses such as paying early or promoting the product.
  - Discounts
  - Allowances
Segmented Pricing:
- Used when a company sells a product at two or more prices even though the difference is not based on cost.
Psychological Pricing:
- Considers the psychology of prices, not simply the economics.
- Reference Prices:
  - Prices that buyers carry in their minds and refer to when looking at a given product.
    - Noting current prices
    - Remembering past prices
    - Assessing the buying situation
Promotional Pricing:
- Temporarily pricing products below list price or cost to increase demand.
  - Loss leaders
  - Special event pricing
  - Cash rebates
  - Low-interest financing
  - Longer warranties
  - Free maintenance
Geographical Pricing:
- Used for customers in different parts of the country or the world.
  - FOB pricing
  - Uniformed-delivery pricing
  - Zone pricing
  - Basing-point pricing
  - Freight-absorption pricing
FOB (Free on Board) Pricing:
- Goods are delivered to the carrier, and the title and responsibility pass to the customer.
Uniformed Delivery Pricing:
- The company charges the same price plus freight to all customers, regardless of location.
Zone Pricing:
- The company sets up two or more zones where customers within a given zone pay a single total price.
Basing Point Pricing:
- A seller selects a given city as a “basing point” and charges all customers the freight cost associated from that city to the customer location, regardless of the city from which the goods are actually shipped.
Freight Absorption Pricing:
- The seller absorbs all or part of the actual freight charge as an incentive to attract business in competitive markets.
Dynamic Pricing:
- Prices are adjusted continually to meet the characteristics and needs of individual customers and situations.
International Pricing:
- Prices are set in a specific country based on country-specific factors.
  - Economic conditions
  - Competitive conditions
  - Laws and regulations
  - Infrastructure
  - Company marketing objectives

Price Changes

Initiating Price Changes:
- Price cuts occur due to:
  - Excess capacity
  - Increased market share
- Price increases occur due to:
  - Cost inflation
  - Increased demand
  - Lack of supply
Buyer Reactions to Price Changes:
- Price increases
  - Product is “hot.”
  - Company greed
- Price cuts
  - New models will be available.
  - Models are not selling well.
  - Quality issues

Public Policy and Pricing

Pricing Within Channel Levels:
- Price fixing: Sellers must set prices without talking to competitors.
- Predatory pricing: Selling below cost with the intention of punishing a competitor or gaining higher long-term profits by putting competitors out of business.
Pricing Across Channel Levels:
- Retail (resale) price maintenance: A manufacturer requires a dealer to charge a specific retail price for its products.
- Deceptive pricing: A seller states prices or price savings that mislead consumers or are not actually available.
- Scanner fraud: Failure of the seller to enter current or sale prices into the computer system.
- Price confusion: Firms employ pricing methods that make it difficult for consumers to understand the price they are really paying.