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.