Chapter 10: Pricing the Product

1. Yes, but what does it cost?

Question of establishing price is a central part of marketing decision making.
Price = the value that customers give up or exchange to obtain a desired product.
Payment may be in the form of money, service, favours, votes or anything that has value
to the other party.
Opportunity cost = cost or value of something that is given up to obtain something
else.
Reasonable price = a price that makes the product affordable and that appears to be
fair the most important consideration in a purchase and one that counts the most when
they decide where to shop.

2. Developing pricing objectives

Six steps in price planning:

1.
1. develop
develop 4.
4. Evaluate
Evaluate the
the 5.
5. Choose
Choose aa
2. Estimate
2. Estimate 3.
3. Determine
Determine 6.
6. Develop
Develop
pricing
pricing pricing
pricing pricing
pricing
demand
demand costs
costs pricing tactics
pricing tactics
objectives
objectives environment
environment strategy
strategy

Step 1: Develop sales or market share objectives

Pricing objectives must support the broader objectives of the firm, such as
maximising shareholder value as well as its overall marketing objectives, such as
increasing market share
Often, the objective of a pricing strategy is to maximise monetary sales or to
increase market share.
If a product has a CA, keeping price at the same level as competition may
satisfy sales objectives.
Profit Objectives
a profit objective is important to firms who believe profit is what
motivates shareholders and bankers to invest in a company.
When pricing strategies are determined by profit objectives, the focus
is on target level of profit growth or a desired net profit margin.
Profits are critical when the product has a short market life the firm
must achieve profits before customers lose interest and move on to
the next fashion or fad.
Competitive effect objectives
Pricing plan is intended to have a certain effect on the competitions
marketing efforts.
May delivery seek to pre-empt or reduce the effectiveness of one or
more competitors
Customer satisfaction objectives
Many quality-focused firms believe profits result from making customer
satisfaction the 1st objective.
By focusing on short-term results they believe the firm loses sight of
keeping customers for the long term.
Image enhancement objectives
price is an important means of communicating not only quality but
also image to prospective customers.
 Customers often use price to make inferences about the quality of a
product.
The image enhancement function of pricing
is particularly important with prestige
products. (high price and appeal to status
conscious customers).

Step 2: Estimate demand

Demand = Customers desires of a product, how much of
a product are customers willing to buy as the price goes up
or down. one of the first step in price planning

Demand curves
= Shows the quantity of a product that customers will
buy in a mkt during a period of time at various prices
if all other factors remain the same.
Demand curve: illustrates the effect of price
on the quantity demanded of a product.
Demand curve for most products slopes
downward and to the right.
Law of demand = as price goes up
customers are willing to buy less.
Exception: quantity relationship:
Backward-bending demand curve is
associated with prestige products: people
desire a product more as it increases in price
(seen as more valuable). If the price
decreases, product less desirable and D may
decrease.
(!) Still has its limits.: increases the price
too much make the product unaffordable and
the demand will begin to decrease again.

Shifts in demand
- If an upward shift occurs, demand at a certain price is greater than before.
Total revenues go up unless the advertising effort was more expensive
- Changes in the environment or in company efforts can cause a shift in the
demand curve (eg. advertising campaign, improvement of a product).
- Demand for new products may influence the demand for old ones.
- Demand curve may also shift downward.

Estimating demand
- Firms production schedule is based on anticipated demand must
be estimated well in advance
- Marketers predict total demand by multiplying number of buyers (or
potential buyers) by nbr of units (estimated) purchased per
customer. Next step is to predict what the companys market share
is likely to be.
- Need to take into consideration other factors that might affect
demand
#buyers * #products likely to purchase
 The price elasticity of demand
Measures how sensitive customers are to changes in price. Critical to
understand whether a change in price will have a large or
small impact on Demand.

change quantity demanded

Price elasticity of demand=
change price

- Elastic demand = Customers are very sensitive to

changes in prices.
1. Elastic demand changes in price and in total
revenues work on opposite direction
2. more horizontal demand curve
3. If price increases Revenue decreases
4. If price elasticity > 1: demand is elastic

1 Inelastic demand = Change in price tends to have little or no effect on

the quantity that consumers are willing to buy.
1 changes in price and in total revenues work in the same direction.
2 more vertical demand curve
3 If price elasticity < 1: demand is inelastic.

Generally, demand for necessities such as food and electricity is inelastic.

Companies can determine the actual price elasticity only after they have tested
a pricing decision and calculating the resulting demand.
Researchers vary prices in different shops to measure how much is purchased at
each price (field studies).
Other factors can affect price elasticity and sales
If a product has a close substitute, its demand will be elastic. Marketers of
products with close substitutes are less likely to compete on price
Consumers could easily switch (profit).
Cross-elasticity of demand
= when changes in prices also affect the demand of another item.
When products are substitutes, price increased in one will increase
demand for the other. Eg. If price of bananas , consumers may instead
buy +strawberries or apples.
When products are complements, an increase in the price of one
decreases the demand for the second. Eg. If price of petrol , consumers
may take public transport instead D for tyres .

Step 3: Determine Costs

While determining price of a product, make sure the price will cover costs.
Types of costs
a) Variable costs = per-unit costs of production that will fluctuate depending
on how many units or individual products a firm produces.
(!) As the nb of products manufactured or average variable costs may
change. BUT VC dont always go down with higher levels of production (i.e.
Pay employees over time to keep up with production; buy additional
material from a distant supplier charge more to cover shipping costs).

b) Fixed costs = Costs that do not vary with the

number of units produced. Eg. Rent, cost of owning
 and maintaining the factory, utilities, equipment, salaries of a firms
executives ( (!) Cost of factory workers = VC).
Average fixed cost = fixed cost per unit: total fixed costs / nb of
units produced.
As we produce more units, AFC goes down so does the price we must
charge to cover costs. In the long term total FC may change (like VC).
In the long term, FC can change
Combining VC & FC = Total costs. both can change
As total costs fluctuate with differing levels of production Price needed to
cover costs fluctuates. Marketers need to calculate min price necessary to
cover all costs = Break-even price.

Break-even Analysis = Technique to examine

the relationship btw cost and price, & to determine
what sales volume must be reached at a given
price before the company will completely cover its
total costs, so will start making a profit.

Break-even point = point at which the company does not

lose any money and does not make a profit. If sales are above the BEP, the
company makes a profit (and ><).
Need 1st to determine Contribution per unit = Difference between the
price the firm charges for a product and the VC.

Profit goal = euro profit a firm desires to earn. Not BEP but target amount:
BEP (in units with target profit included) = (total FC + target profit) / contribution
per unit to FC
Sometimes the target return or profit goal is expressed as a percentage of sales.
this profit is added to the variable cost on calculating the break-even point.
Does not provide an easy answer for pricing decisions answers about how
many units the firm must sell to break even and make a profit we dont know
if the demand = quantity at that price
Marginal analysis
Provides a way to look at cost and demand at the
same time and to identify output and price that will
generate maximum profit.
Marketers examine the relationship btw:
Marginal cost = increase in total costs from
producing one additional unit. &
Marginal revenue = increase in total income that
results from selling one additional unit.

Average revenue represents the demand curve. Predicting D = never an

Average revenue and marginal revenue decrease with exact science. Most firms
each additional unit sold. find the BEP analysis
approach more useful.
 After the first unit, the cost of producing each additional unit and the average
cost at first decrease.
both marginal cost and average costs increase since average fixed costs and
average variable costs may increase in the long term
Profit is maximised at the point at which marginal cost is exactly equal to
marginal revenue. the cost of producing one unit is exactly equal to the revenue
to be realised from selling that one unit dont produce more
(!) Costs and Revenues may vary unexpectedly (Shortages, Economy) Difficult to
estimate.

Step 4: Evaluate the pricing environment

Marketers must look at factors in the firms external environment when they make
pricing decisions. To provide a CA a price that meets the needs of customers
better than the competition.

The economy
- Business cycle, economic growth, inflation and consumer confidence affect
pricing strategy determine whether one pricing strategy or another will
succeed
- In recession, consumers become more price-sensitive (even wealthy
households) Many firms set price to levels at which costs are covered but
the company doesnt make a profit to keep factories in operation.
- Inflation may give marketers the possibility to increase or decrease prices.
1st, inflation gets customers used to price . Customers may remain
insensitive after inflation. But if customers cut back on expenditures, firms
may reduce prices during inflation to keep sales stable.

The competition
- Price wars can change consumers perceptions of what is a fair price,
leaving them unwilling to buy at previous price levels.
- Industry structure will influence price decisions (Oligopoly, Monopolistic,
Pure Competition).
In Oligopoly (few sellers/many buyers), pricing is similar among
competitors status quo pricing objectives (eg. Airline KLM).
Monopolistic competition (lots of sellers), differentiate products and focus
on non-price competition (eg. restaurant industry).
In purely competitive mkt, little opportunity to raise or lower prices.
Price is directly influenced by supply & demand (eg. commodity goods
like wheat farmers).

Consumer trends
- Culture and demographics determine how consumers think and behave
impact all marketing decisions
- Strategic shopping = New interest in hunting for sales (Even luxury
consumers).

Step 5: Choose a price strategy

One doesnt charge enough and the other too much
Making pricing moves and countermoves requires thinking two and three moves
ahead

Pricing strategies based on cost

- cost-based strategies = Simple to calculate and risk-free Price will
cover at least costs in marketing and producing.
 - Cost-based pricing methods have drawbacks: do not consider factors such
as nature of target mkt, demand, competition, product life cycle & products
image. + Accurate cost estimating may prove difficult (ex: firms that have
many products)
- Cost-plus-pricing = (most common cost-based approach) marketer totals
all the costs for the product and then adds an amount to arrive at the selling
price. Calculate either mark-up on cost or on selling price (= add a
predetermined percentage to the cost)

Pricing strategies based on demand

- Demand-based pricing = selling price is based on estimate of volume or
quantity that a firm can sell in different markets at different prices Firms
must determine how much they can sell in each market and at what price
(use customer surveys or field experiments). 2 approaches:
Target costing = Firm first determines price at which costumers are
willing to buy the product and then work backwards to design the product
in such a way that it can produce and sell the product at a profit.
Step1: Determine the price customers are willing to pay.
Step 2: Determine markup required by retailer.
Step 3: Calculate the max price the retailer will pay, the price
customers are willing to pay minus the markup amount.
Step 4: Determine the profit required by the firm.
Step 5: Calculate target cost, the max cost of producing the product.

Price to retailer = Selling price x (1- markup

percentage)
Target cost = Price to the retailer x (1- profit
percentage)

Yield-management pricing = Charging different prices to different

customers in order to manage capacity while maximising revenues
(Different customers have different sensitivity to prices; eg. airlines,
hotels, cruise lines). Companies estimate proportion of customers that
fall into each segment and then manage capacity accordingly (so that no
product goes unsold).

Pricing strategies based on the competition

Price-leadership strategy = is the rule in oligopolistic industry dominated
by few firms popular as they provide acceptable and legal way for firms to
agree on prices without ever talking wth each other. minimize price
competition

Pricing strategies based on customers needs

Less concerned with short-term results than with keeping customers for the
long term.
- Value pricing/Everyday low pricing (EDLP) = develop pricing strategy
that promises ultimate value to consumers (In customers eyes the price is
justified by what they receive).
- Value-based pricing strategies begin with customers, then consider the
competition and then determine the best pricing strategy.

New product pricing

Skimming price = firm charges high, premium price for its new product
with the intention of reducing it in the future in response to market
pressures.
 penetration pricing strategy or trial pricing
If product is highly desirable & offers unique benefits, demand is price
inelastic in introductory stage company recovers R&D and
promotional costs.
When rivals enter, the price is lowered to remain competitive.
Firms focusing on profit objectives often set skimming prices for new
products.
Skimming price is more likely to succeed if: product provides some
important benefits, should be little chance that competitors can get into
the mkt quickly, if there are different segments with different levels of
price sensitivity.
Penetration pricing = (opposite of skimming) new product is priced
very low in order to sell more to gain market share. Used to discourage
competitors from entering (barrier to entry). Pioneering brand is often
able to maintain market share for long period of time.
Trial pricing = New product carries a low price for a limited period of
time to generate high level of customer interest. Trial price is increased
after introductory period. win customer acceptance first and make
profit later

Step 6: Develop pricing tactics

Pricing tactics = Methods companies use to set their strategies in motion.

Pricing for individual products

Two part-pricing = requires 2 separate types of payments to purchase
the product (eg. mobile phone service: offer customers # of minutes plus
a per-minute rate for extra-usage).
Payment pricing = makes the consumer think that the price is do-able
by breaking up the total price into smaller amounts payable over time
less sensitive to the total price (eg. Monthly lease amount of a car).

Pricing for multiple products

Price bundling = selling two or more goods or services as a single
package for one price. (eg. Concert series). If priced separately, it is
likely that consumers might buy some but not all items buy them
later or from competitors
make up from the reduced price in increased total purchases
Captive pricing = When a firm has two products that work only when
used together. The firm sells one item at a very low price and then
makes profit on the second high-margin item. (eg. razor blades).

Distribution-based pricing
= Pricing tactic that establishes how firms handle the cost of
shipping products to customers near, far and wide.
- Title passes to buyer at the FOB (free on board) location.
- FOB factory/origin pricing = cost of transporting the product from the
factory to the customers location is the responsibility of the customer.
- FOB delivered pricing = seller pays both the cost of loading and
transporting to the customer, which is included in the selling price.
- CIF (Cost, Insurance, Freight) = seller quotes price to the point of
debarkation from the vessel, used for ocean shipments.
- CFR (Cost & Freight) = quoted price covers goods and cost of transportation
to the named point of debarkation but the buyer must pay the cost of
insurance ocean shipments.
 - CIP (Carriage and insurance paid to) & CPT (Carriage paid to) = include
same provisions as CIF and CFR but are used for shipment by modes other
than water.
- Base-point pricing = marketers choose one or more locations to serve as
base point, customers pay shipping charges from these base points to their
delivery destinations whether the goods are actually shipped from these
points or not.
- Uniform-delivered pricing = adds average shipping cost to the price, no
matter what the distance from the manufacturers plant
- Freight-absorption pricing = sellers takes on part or all of the cost of
shipping (works for high-ticket items & in highly competitive mkts).

Discounting for channel members

List price (recommended retail price: RRP) = price manufacturer sets
as appropriate price for end consumer to pay. Discounts, so that
wholesalers and retailers can make a profit and cover their own costs:
Trade or dysfunctional discounts: because members perform
selling, credit, storage and transportation services that the
manufacturer would have to pay otherwise % discounts off list
price for each channel level.
Quantity discounts: reduced prices for purchases of larger
quantities.
Cumulative quantitative discounts: based on a total quantity
bought within a specified time period & encourage a buyer to
stick with a single seller (may be in the form of rebates).
Non-cumulative quantity discounts: based on the quantity
purchased with each individual order & encourage larger single
orders no tie
Cash discounts: firms try to receive cash quickly by offering
discounts.
2 percent 10 days, net 30 days if paid within the 10 days, buyer
receives 2% off
Seasonal discounts: price reductions during certain times in the
year (to encourage buying off-season) buyer will store them until
the right time or pass the discount to customers with off-season sales
programme

3. Pricing and electronic commerce

E-commerce makes it possible to tailor offerings for customers. Internet means:
consumers can find easily the price of competitors
B2B: firms can change prices rapidly to adapt to changing costs
C2C: opportunity for consumers to find ready buyers.

Dynamic Pricing strategies

Dynamic pricing = seller can easily adjust price to meet changes in the
marketplace.
respond quickly if necessary frequently to changes in costs, in supply, and
or demand
Easy and quick with E-commerce: cost of changing prices on the web is
very low.

Auctions
Online auctions allow shoppers to bid on items.
Open auction = all buyers know highest bid at any point in time.
Reserve price = price below which the item will not be sold.
 Pricing advantages for online shoppers
Consumers & business customers are gaining +control over the buying
process. With the availability of search engines (can find info about costs to
the manufacturer), they are no longer at mercy of firms. Customers have
become more price-sensitive.
- E-commerce potentially can lower consumers costs because of the time and
hassle associated with a trip to the shops/supermarket.

4. Psychological issues in pricing

Buyers Pricing Expectation
Often customers base their perception of price on what they
perceive as the customary/fair price. When the price of a product is
above or even sometimes when its below what consumers expect,
they are less willing to purchase the product. (above rip off; below
quality is below par)

o Internal reference prices

Customers have set price based on past experiences or average of prices.
Assimilation effect = If prices of two products are close, customer
will feel that they have a similar quality take the cheaper one.
Contrast effect = Customer equates price difference with difference
in quality. take the pricier one (seen as better quality)

o Price/Quality inferences
= When customers use price as a cure or an indicator of quality. If
consumers are unable to judge the quality of a product through examination
or experience, they usually will assume that the higher priced product is the
higher quality product.

Psychological Pricing Strategies

o Odd-Even pricing
Marketers assume that there is a psychological response to odd prices that
differs from responses to even prices. Theatre and concert tickets,
admission to sporting events, lottery tickets, professional fees, luxury items
tend to have even price set them apart

o Price lining
Price lining = When items in a product line are sold at different prices
(price points) and provides the different ranges necessary to satisfy each
segment of the mkt (each price falls at the highest possible price for each
customer category).

5. Legal and ethical considerations in pricing

Free enterprise system is based on idea that marketplace will regulate itself.
Regulations are imposed to make EU a more level playing field price can
vary by 30% in countries
national and local governments have found it necessary to enact legislation to protect
consumers and protect businesses from predatory rivals.

Deceptive pricing practices

Bait-and-switch = retailer will advertise item at very low price (bait) to lure
customers into shop to sell more expensive item (switch) because almost
 impossible to buy the advertised item. salesman will say that the bait is
nailed to the floor
Loss leaders
Loss leader pricing = sell one item at loss, because firm knows once in the
shop customers will buy other items as well, this strategy is aimed at
building traffic and sales volume.

Price fixing
Price fixing = when two or more companies conspire to keep prices at a
certain level.
Horizontal price fixing = when competitors making the same
product jointly determine what price each will charge must be an
exchange of pricing info between sellers to indicate illegal action
not just copying the price of others
Vertical price fixing = manufacturers or wholesalers try to force
retailers to charge certain price for product recommended retail
price

Predatory pricing
= Company sets a very low price to drive competition out the market
Later, when they take over the supply and have a monopoly, they will
increase prices.