Pricing: Understanding and Capturing Customer Value

Definition and Importance of Pricing

• Definition of Price: Price is the amount of money charged for a product or service.
• Strategic Role: Price is a critical variable that determines a firm’s market share and its level of profitability.
• Revenue Generation: Price is the only element in the marketing mix that produces revenue; all other elements represent costs.

Considerations in Setting Price (Figure 8.1)

• Pricing Balancing Act: Setting the "right" price involves delivering value to the customer while ensuring profits for the company. It exists between two extremes:

  • Price Ceiling: This is defined by consumer perceptions of value. There is no demand for the product above this price. If customers perceive that a product's price is greater than its value, they will not buy it.
  • Price Floor: This is defined by product costs. No profits are possible below this price point. If a company prices a product below its costs, profits will suffer.

• Core Factors in Price Setting:

  • Product Costs (Price Floor): Includes the cost of producing, marketing, and delivering the product. A company cannot sustain selling below this price long-term without incurring losses.
    • Example: A bakery spends $RM5$ to make a cake (ingredients, labour, packaging). The selling price must be set above $RM5$.
  • Competition and External Factors: Includes competitors' strategies and prices, marketing strategies, objectives, the marketing mix, the nature of the market, and demand.
    • Example: If nearby caf s sell coffee for $RM8$, it may be difficult to charge $RM15$ unless the caf offers a unique value proposition.
  • Consumer Perceptions of Value (Price Ceiling): The maximum amount customers are willing to pay based on the value they perceive.
    • Example: Customers may be willing to pay $RM4,000$ for an iPhone because they perceive it as having high quality and prestige.

Major Pricing Strategies

Customer Value-Based Pricing

• Core Principle: Pricing is based on buyers’ perceptions of value rather than on the seller’s cost.
• Process Order: Price is considered and set before the marketing program is fully developed.
• Types of Value-Based Pricing:
  • Good-value pricing: Offering the specific combination of quality and good service at a fair price.
    • Example: Perodua cars are priced affordably while maintaining reliability, fuel efficiency, and low maintenance costs.
  • Value-added pricing: Attaching value-added features and services to differentiate the company’s offer, thereby supporting a higher price.
    • Example: Tesla charges premium prices due to advanced technology, software updates, autonomous driving features, and brand prestige.

Cost-Based Pricing

• Core Principle: Prices are set based on the costs of producing, distributing, and selling the product, plus a fair rate of return for the company's effort and risk.
• Types of Costs:
  • Fixed costs (overhead): Costs that do not vary with production or sales levels (e.g., Rent, salaries, insurance).
  • Variable costs: Costs that vary directly with the level of production (e.g., Raw materials, packaging, commissions).
  • Total costs: The sum of fixed and variable costs for any given level of production ($Total \, Costs = Fixed \, Costs + Variable \, Costs$).
• Methods of Cost-Based Pricing:
  • Cost-plus pricing (markup pricing): Adding a standard markup to the cost of the product.
  • Break-even pricing (target return pricing): Setting a price to break even on the costs of making and marketing a product, or setting a price to achieve a specific target return. This is often illustrated using a Break-Even Chart.

Competition-Based Pricing

• Core Principle: Setting prices based on competitors’ strategies, costs, prices, and market offerings.
• Assessment Questions for Competition:
  • How does the company’s market offering compare to competitors in terms of customer value?
  • How strong are the current competitors in the market?
  • What are the competitors' current pricing strategies?

Comparing Value-Based vs. Cost-Based Pricing

• Cost-Based Pricing Sequence:

  1. Design a good product.
  2. Determine product costs.
  3. Set price based on cost.
  4. Convince buyers of the product's value.
  • Focus: Internal factors (costs). Common for basic or commodity products.

• Value-Based Pricing Sequence:

  1. Assess customer needs and value perceptions.
  2. Set target price to match customer-perceived value.
  3. Determine costs that can be incurred.
  4. Design product to deliver desired value at the target price.
  • Focus: External factors (customer needs). Common for premium brands and innovative products.

Internal and External Factors Affecting Price

• Internal Factors:
  • Overall marketing strategy, objectives, and mix.
  • Organizational considerations: Who within the organization sets the prices?
• External Factors:
  • Nature of the market and demand.
  • Economy (inflation, interest rates, recession/boom).
  • Impact on other parties in the environment (resellers, government, social concerns).

Case Application: AirAsia

• Overall Marketing Strategy: AirAsia follows a low-cost airline strategy, keeping ticket prices affordable to attract budget travelers.
• Organizational Considerations: Prices must be high enough to cover fuel costs, aircraft maintenance, and staff salaries.
• Market and Demand: Ticket demand increases during school holidays and festive seasons, leading to higher prices.
• Economy: In a weak economy, AirAsia offers promotions to encourage bookings from price-sensitive travelers.
• Impact on Other Parties: If AirAsia lowers fares, competitors such as Malaysia Airlines may introduce special promotions to remain competitive.

Pricing in Different Market Types

• Pure Competition:
  • Number of Sellers: Many.
  • Product Type: Identical.
  • Pricing Power: Very Low.
  • Example: Farmers selling vegetables.
• Monopolistic Competition:
  • Number of Sellers: Many.
  • Product Type: Differentiated.
  • Pricing Power: Moderate.
  • Example: Starbucks vs. Zus Coffee.
• Oligopolistic Competition:
  • Number of Sellers: Few (dominated by a few large sellers).
  • Product Type: Similar.
  • Pricing Power: High but depends on competitors.
  • Example: Maxis, CelcomDigi, U Mobile.
• Pure Monopoly:
  • Number of Sellers: One.
  • Product Type: No substitute.
  • Pricing Power: Very High.
  • Example: Water supply provider.

Demand and Elasticity

• Demand Curve (Alfred Marshall, 1890): Explains the Law of Demand, stating that as price increases, the quantity demanded decreases ($Price \uparrow \rightarrow Quantity \, Demanded \downarrow$), assuming all other factors remain constant.
• Price Elasticity of Demand: Measure of how sensitive demand is to changes in price.
  • Inelastic Demand: Demand hardly changes with a small change in price (e.g., Petrol, which is a necessity).
  • Elastic Demand: Demand changes significantly with a small change in price (e.g., Movie tickets; if prices rise, customers may simply skip the movie).

Economic Influences and Frugality

• Economic Factors: Pricing is impacted by booms, recessions, inflation, and interest rates.
• Frugality: The practice of being economical, thrifty, and resourceful with resources like money, food, and time.
• Post-Recession Responses: To address the frugality of consumers, companies may:
  • Cut prices and offer discounts.
  • Develop more affordable product items.
  • Redefine their value propositions.

New Product Pricing Strategies

Market-Skimming Pricing (Price Skimming)

• Description: Setting a high initial price to "skim" maximum revenues layer by layer from the segments willing to pay the high price.
• Result: The company makes fewer but more profitable sales.
• Case Example: PlayStation 5 (PS5):
  • High Initial Price: Sony launched the PS5 at approximately $RM2,299$.
  • Early Adopters: Hardcore gamers and loyal fans bought the product immediately at the high price.
  • Adjustments: Over time, Sony introduced bundles and discounts to reach other segments.

Market-Penetration Pricing

• Description: Setting a low initial price to attract a large number of buyers and a large market share quickly.
• Case Example: Shopee:
  • Free Shipping: Offered to attract a massive user base.
  • $RM1$ Deals: Attractive low-cost deals encouraged customers to try the platform.
  • Cashback Vouchers: Provided more savings to retain users.
  • Outcome: Attracted millions of users to join the platform.

Product Mix Pricing Strategies

Price Adjustment Strategies

• Discount and allowance pricing: Reducing prices to reward customer responses (e.g., volume purchases, early payment, or promotion assistance).
• Segmented pricing: Adjusting prices to account for differences in customers, products, or locations.
• Psychological pricing: Adjusting prices for psychological effect (perceived value over actual cost).
• Promotional pricing: Temporarily reducing prices to spur short-run sales.
• Geographical pricing: Adjusting prices to account for the geographic location of customers.
• Dynamic pricing: Adjusting prices continually to meet the characteristics and needs of individual customers and situations.
• International pricing: Adjusting prices for international markets based on local conditions.

Initiating and Reacting to Price Changes

Initiating Price Changes

• Reasons for Price Cuts:
  • Excess capacity.
  • Falling demand.
  • Attempting to dominate the market.
• Reasons for Price Increases:
  • Cost inflation.
  • Over-demand (when the company cannot supply all its customers).

Reactions to Price Changes

• Buyer’s Perspective:
  • Price Increase: May perceive the product as more exclusive/better made, or may feel the company is being greedy.
  • Price Cut: May feel they are getting a better deal, or may suspect the product's quality has been reduced or the brand image is tarnished.
• Competitor’s Perspective on a Price Cut:
  • The company is trying to grab market share.
  • The company is doing poorly and trying to boost immediate sales.
  • The company wants the entire industry to cut prices to increase total market demand.