Chapter 15 -- Designing Pricing Strategies and Programs

OVERVIEW:

Price has become one of the more important marketing variables. Despite the increased role of nonprice factors in the modern marketing process, price is a critical marketing element, especially in markets characterized by monopolistic competition or oligopoly. Competition and more sophisticated buyers has forced many retailers to lower prices and in turn place pressure on manufacturers. Further, there has been increasing buyer awareness of costs and pricing, and growing competition within the channels, which in turn provides the consumer with even more awareness of the pricing process.

In setting the price of a product, the company should follow a six-step procedure. First, the company carefully establishes its marketing objective(s), such as survival, maximum current profit, maximum current revenue, maximum sales growth, maximum market skimming or product-quality leadership. Second, the company determines the demand schedule, which shows the probable quantity purchased per period at alternative price levels. The more inelastic the demand, the higher the company can set its price. Third, the company estimates how its costs vary at different output levels, production levels, different marketing strategies, differing marketing offers, and target costing based on market research. Fourth, the company examines competitors' prices as a basis for positioning its own price. Fifth, the company selects one of the following pricing methods: markup pricing, target return pricing, perceived-value pricing, value-pricing, going-rate pricing, and sealed-bid pricing. Sixth, the company selects its final price, expressing it in the most effective psychological way, coordinating it with the other marketing mix elements, checking that it conforms to company pricing policies, and making sure it will prevail with distributors and dealers, company sales force, competitors, suppliers, and government.

Companies will adapt the price to varying conditions in the marketplace. Geographical
pricing is one marketplace adjustment based on a company decision related to pricing distant customers. Price discounts and allowances are a second area for adjustment where the company establishes cash discounts, quantity discounts, functional discounts, seasonal discounts, and allowances. Promotional pricing provides a third marketplace option, with the company deciding on loss-leader pricing, special-event pricing, cash rebates, low interest financing, longer payment terms, warranties and service contracts and psychological discounting. Discriminatory pricing, the fourth option, enables the company to establish different prices for different customer segments, product forms, brand images, places, and times. Lastly, product-mix pricing, enables the company to determine price zones for several products in a product line, as well as differential pricing for optional features, captive products, byproducts, and product bundles.

When a firm considers initiating a price change, it must carefully consider customer and competitor reactions. Customer reactions are influenced by the meaning customers see in the price change. Competitor reactions flow either from a set reaction policy or from a fresh appraisal of each situation. The firm initiating the price change must also anticipate the probable reactions of suppliers, middlemen, and governments.

The firm encountering a competitor-initiated price change must attempt to understand the competitor's intent and the likely duration of the change. If swiftness of reaction is desirable, the firm should preplan its reactions to different possible competitor price actions.

To summarize, pricing involves the customer demand schedule, the cost function, and competitors’ prices. The question is how should a company integrate cost-, demand-, and competition-based pricing considerations? In setting a price the firm, for example Kodak, will have to consider the following cost-, demand-, and competition-based pricing decisions:

Cost-based pricing decisions -- Marginal analysis and break-even analysis are the two primary methods in cost-based pricing decisions:

- What is the impact of a 5 per cent cost increase in the price of silver on film costs?

- Should Kodak attempt to purchase silver futures to reduce the volatility of silver costs?

- What is the impact on film manufacturing and marketing costs of a 10 per cent demand reduction?

Demand-based pricing decisions -- Among the variables here the type of demand for the product (prestige, price-oriented, etc.), changes in buyer attitude toward price with changes in the economic environment (uncontrollable variables), and the elasticity of demand

- What is the elasticity of demand by market segment (amateur photographer, professional photographer, and X-ray market)?

- Are the short- and long-range effects of price increases the same?

- Will consumers switch to slow-speed films which contain less silver?

Competition-based pricing decisions -- To set prices effectively, an organization must be aware of the prices charged by competitors.

- Among the major questions here are: Will all competitors raise their prices by the same percentage? Will competitors react to cost increases more slowly to try to increase their market share? Will some competitors try to absorb much of the cost increases to induce brand switching?

LEARNING OBJECTIVES:

After reading the chapter the student should understand:

CHAPTER OUTLINE:

  1. Introduction
  2. Setting the Price - a firm must set the price for the first time when the firm develops or acquires a new product, when it introduces its regular product into a new distribution channel or geographical area, and when it enters bids on new contract work.
    1. Selecting the Pricing Objective
      1. Survival
      2. Maximum current profit
      3. Maximum current revenue
      4. Maximum sales growth - aims is market share, penetration pricing is used
      5. Maximum market skimming - appeals only to the higher market segments
      6. Product-quality leadership - premium quality connotes premium price
      7. Other Pricing Objectives - cost recovery (partial or full), social pricing
    2. Determining Demand
      1. Factors affecting price sensitivity (unique-value, substitute-awareness, difficult-comparison, total-expenditure, end-benefit, shared-cost, sunk-investment, price-quality, and inventory effects)
      2. Methods of estimating demand curves - statistical analysis, price experiments, buyer input
      3. Price elasticity of demand - determination of the affect of a change in price on overall demand. If demand changes considerably with a change in price, it is elastic. If it does not change, it is inelastic.
    3. Estimating Costs
      1. Types of costs - fixed, variable and total costs
      2. Cost behavior at different levels of production per period
      3. Cost behavior as a function of accumulated production - "the learning curve"
      4. Cost behavior as a function of differentiated marketing offers - ABC accounting
      5. Target costing - determine price that must be charged according to market research
    4. Analyzing Competitors' Costs, Prices and Offers
    5. Selecting a Pricing Method
      1. Markup pricing - markup is standard, but can vary according to product categories
      2. Target return pricing - to make a fair return on investment
      3. Perceived value pricing - according to buyer’s perceptions
      4. Value pricing - fairly low price for a high quality offering, everyday low pricing
      5. Going rate pricing - base price on that of competitors’.
      6. Sealed-bid pricing - price is based on expectations of how competitors will price
    6. Selecting the Final Price
      1. Psychological pricing
      2. The influence of other marketing mix elements on price - relationship among relative price, relative quality and relative advertising
      3. Company pricing policies - contemplated price must be consistent
      4. Impact of price on other parties - distributors, sales force, competitors, suppliers, government, etc.
  3. Adapting the Price
    1. Geographical Pricing
    2. Price Discounts and Allowances
      1. Cash discounts
      2. Quantity discounts
      3. Functional (trade) discounts
      4. Seasonal discounts
      5. Allowances, trade-in or promotional
    3. Promotional Pricing
      1. Loss-leader pricing - to stimulate traffic
      2. Special event pricing - to draw customers
      3. Cash rebates - to encourage purchase within a specified time period
      4. Low-interest financing - to facilitate purchase
      5. Longer payment terms - for lower monthly payments
      6. Warranties and service contracts - added value
      7. Psychological discounting - set an artificially high initial price
    4. Discriminatory Pricing
      1. Customer-segment pricing - different prices for different groups
      2. Product-form pricing - different versions priced differently
      3. Image pricing - same product at two different levels
      4. Location pricing - same product priced differently at different locations
      5. Time pricing - same product priced differently at different day, time or season
    5. Product-Mix Pricing
      1. Product-Line Pricing - price steps
      2. Optional-feature pricing - in addition to main product
      3. Captive-product pricing - main products that require ancillary products
      4. Two-part pricing - fixed fee plus variable fee based on usage
      5. Byproduct pricing - to recoup production costs of main product
      6. Product-bundling pricing - less costly when purchased together
  4. Initiating and Responding to Price Changes
    1. Initiating Price Cuts - either due to excess capacity or a drive to dominate the market. The latter strategy has high risks.
    2. Initiating Price Increases - can considerably increase profits. Occurs due to cost inflation or overdemand
    3. Reactions to Price Changes
      1. Customers’ reactions
      2. Competitors’ reactions
    4. Responding to Competitors’ Price Changes - maintain price, raise perceived quality, reduce price, increase price and improve quality, launch low-price fighter line
  5. Summary