Chapter 10 - What is the value proposition worth

pricing strategies based on consumers' needs

In 1960, Lee Iacocca, then the Ford Division general manager, noted forecasts that the baby boomer generation was coming of age, which meant that Ford would face an increasing number of young car buyers. There were also indications that these young car buyers would like a stylish sports car but couldn't afford the $4,000 to $7,000 price tag on the Ford Thunderbird or the GM Corvette. Under Iacocca's direction, Ford began developing a car that had the style and features young drivers desired but at a cost they could afford. This car, of course, was the iconic Ford Mustang. Priced at an amazingly low $2,500, Ford sold more than 400,000 Mustangs in the first year and in two years made over $1 billion in profits from the car.18 Retailers typically practice one of two pricing strategies based on customer's needs: EDLP and high/low pricing. Firms that practice value pricing, or everyday low pricing (EDLP) develop a pricing strategy that promises good quality and durable products at reasonable prices every day. Many successful retail chains around the world—including Walmart, Kmart, Home Depot, Office Depot, Toys "R" Us, Target, and Tesco—all adopt a deliberate policy of EDLP. Because of their size, these firms are able to demand billions of dollars in cost efficiencies from their suppliers and pass the savings on to customers. The high/low pricing, or promo pricing, strategy means retailers have prices that are higher than EDLP chains, normally the MSRP or list price, but they run frequent, often weekly, promotions that heavily discount some products. So what happens if retailers seek to switch from one strategy to the other? Sears, for example, has switched from high/low to EDLP and then back to high/low. JC Penney also tried to switch from a high/low strategy to EDLP and failed. New Product Pricing New products are vital to the growth and profits of a firm, but they also present unique pricing challenges. When a product is new to the market or when there is no established industry price norm, marketers may use a skimming pricing strategy, a penetration pricing strategy, or trial pricing. A skimming price means that the firm charges a high, premium price for its new product with the intention of reducing it in the future in response to market pressures. If a product is highly desirable and offers unique benefits, demand is price inelastic during the introductory stage of the product life cycle, allowing a company to recover research and development (R&D) and promotion costs. When rival products enter the market, the firm lowers the price to remain competitive. Firms that focus on profit objectives when they develop their pricing strategies often set skimming prices for new products The Sony PlayStation 3 was originally sold at $599 in the U.S. market, but it was gradually reduced to less than $200.19 For skimming pricing to be successful, there should be little chance that competitors can get into the market quickly. With highly complex, technical products, it will take time for competitors to put a rival product into production. Penetration pricing is the opposite of skimming pricing. In this situation, the company prices a new product very low to sell more in a short time and gain market share early. Another reason marketers use penetration pricing is to discourage competitors from entering the market. The firm that first introduces a new product has an important advantage. Experience shows that a pioneering brand often is able to maintain dominant market share for long periods. Campbell's soup, with the iconic red label, is a brand that was first to market in 1895 and still dominates the industry today.20 Trial pricing means that a new product carries a low price for a limited time to generate a high level of customer interest. Unlike penetration pricing, in which the company maintains the low price, the company increases the trial price after the introductory period. The idea is to win customer acceptance first and make profits later, as when a new health club offers an introductory membership to start pulling people in or a cable TV company offers a great low price for six months if you sign up for their TV, Internet, and phone bundle, after which you will pay much more. Price Segmentation Most markets are made up of consumers who have widely different characteristics. As we discussed in Chapter 7, we refer to these as market segments. Just as the same product may not be best for all segments, the best price for a product differs among market segments. Price segmentation is the practice of charging different prices to different market segments for the same product. For example, Captain George's Seafood Restaurant in Myrtle Beach, South Carolina, segments buffet pricing by age. They offer an adult buffet for $35.99, but access to the same buffet for children ages 5-12 is $19.99.21 Segmenting on quantity occurs when the price of one large pizza is $9 but you can get two for $15. Of course marketers must be careful when using customer characteristics as criteria for price differences to avoid discriminating against some customers. The use of characteristics such as gender, race, religion, or ethnic group typically is illegal and should generally be avoided. When the demand for a product differs during predictable periods, sellers often develop a pricing plan that sets prices higher during periods with higher demand. In the same way, a seller may segment based on the time when the purchase is made. This peak load pricing received its name because it was originally used for pricing by electric utility companies. Movie theaters offer lower daytime ticket prices, restaurants offer "early bird" discounts, and the cost of resort hotel rooms is much higher during the summer for beach resorts and winter for resorts on the slopes. As we discussed earlier, Uber is a global online transportation company. Consumers can use the Uber app on their smartphones to request a trip, which is then routed to Uber drivers who use their own cars. Uber uses a surge pricing strategy; it raises the price of its product as demand goes up (as on a rainy Saturday night) and lowers it as demand declines. Think twice before hailing an Uber on New Year's Eve—you may be better off renting a limo! Bottom-of-the-Pyramid Pricing Marketers face a different challenge when they wish to get a foothold in countries with huge populations of people with the lowest incomes, the bottom of the pyramid countries. These marketers need to develop bottom-of-the-pyramid pricing, prices that are low enough to appeal to the large numbers of these consumers. One approach (discussed in Chapter 2) is to sell nondurable products in smaller packages for just a few cents. A second option is for people, perhaps an entire village, to share a product such as a cell phone, a computer, or a refrigerator.

Step 4: Examine the Pricing Environment

In addition to demand and costs, marketers look at factors in the firm's external environment when they set prices. The fourth step in developing pricing strategies is to examine and evaluate the external pricing environment. In this section, we will discuss some important external influences on pricing strategies—the economic environment, competition, and consumer trends. The Economy Broad economic trends, like those we discussed in Chapter 2, tend to influence pricing strategies. The business cycle, inflation, economic growth, and consumer confidence in the economy all help to determine whether a firm should keep prices stable, reduce them, or even raise them. Of course, the upswings and downturns in a national economy do not affect all product categories or all regions equally. Marketers need to understand how economic trends will affect their particular businesses. In general, during recessions, like the Great Recession that began in late 2007, consumers grow more price sensitive. They switch brands to get a better price and patronize discount stores and warehouse outlets. They are less likely to take luxury vacations; instead, they're happy with a "staycation" where they entertain the family at home. Many consumers lose their jobs, and others are fearful of losing theirs. Even wealthy households, relatively unaffected by the recession, tend to cut back on their consumption. As a result, to keep businesses in operation during periods of recession, some firms find it necessary to cut prices to levels at which they cover their costs but don't make a profit. During the Great Recession, Starbucks' strategy to cope with the downturn was to keep a premium image while the chain retained price-sensitive customers who threatened to defect to lower-priced competitors, such as McDonald's. To do this, Starbucks raised the prices of its sugary coffees with several ingredients, such as Frappuccinos and caramel macchiatos, by 10, 15, or even 30 cents. At the same time, the company reduced prices of more popular beverages, such as lattes and brewed coffee, from 5 to 15 cents. P&G is the world's biggest producer of consumer goods, including many premium-priced brands, some at prices twice the category average. But during the recession, P&G found sales, market share, and profits declining as consumers switched to store brands and other cheaper options. P&G responded with a number of price-cutting and product-enhancement strategies. For example, P&G began offering larger packs of Duracell batteries and more absorbent Pampers Baby Diapers without increasing prices. While the kneejerk reaction to a recession is to lower prices in order to hold onto business, sometimes that strategy could be disastrous. Domino's Pizza instead worked on its core product—pizza. A consumer survey revealed negative customer perceptions of Domino's "cardboard crust" and "ketchup sauce." In response, Domino's did what many would believe is unthinkable: The company admitted its product stinks. Domino's overhauled its recipe for an improved pizza, and then it aggressively promoted this change. This brought customers in the door and doubled profits.9 There are also some economic trends that influence what consumers see as an acceptable or unacceptable price range for a product and thus allow firms to change prices. Inflation may give marketers causes to either increase or decrease prices. First, inflation gets customers accustomed to price increases, even when inflation goes away. This allows marketers to make real price increases, not just those that adjust for the inflation. Of course, during periods of inflation, consumers may cut back on purchases because they grow fearful of the future and worry about whether they will have enough money to meet basic needs. Then, as in periods of recession, inflation may cause marketers to lower prices and temporarily sacrifice profits to maintain sales levels. The Competition Marketers try to anticipate how the competition will respond to their pricing actions. It's not always a good idea to fight the competition with lower and lower prices. Pricing wars can change consumers' perceptions of what is a "fair" price, leaving them unwilling to buy at previous price levels. As we discussed in Chapter 2, most industries belong to one of three industry structures—an oligopoly, monopolistic competition, or pure competition. The industry structure a firm belongs to will influence price decisions. In general, firms like Delta Airlines that do business in an oligopoly, in which the market has few sellers and many buyers, are more likely to adopt status quo pricing objectives in which the pricing of all competitors is similar. Such objectives are attractive to oligopolistic firms because avoiding price competition allows all players in the industry to remain profitable. Of course, this doesn't mean that firms in an oligopoly can just ignore pricing by the competition. When one airline raises or lowers the price for its flights, the other airlines follow. In a business like the restaurant industry, which is characterized as monopolistic competition in which there are many sellers, each offering a slightly different product, it is possible for firms to differentiate products and to focus on nonprice competition. Then each firm prices its product on the basis of its cost without much concern for matching the exact price of competitors' products. Organizations like wheat farmers that function in a market characterized as pure competition have little opportunity to raise or lower prices. Rather, supply and demand directly influence the price of products like wheat, soybeans, corn, and fresh peaches. Government Regulation Another important factor in the environment that influences how marketers develop pricing strategies is government regulation. Governments in the U.S. and some other countries develop two different types of regulations that affect pricing. First, regulations for employee health care, environmental protection, occupational safety, and highway safety, just to mention a few, cause the costs to produce many products to increase. Other regulations on specific industries, such as those imposed by the Food and Drug Administration on the production of food and pharmaceuticals, increase the costs of developing and producing those products. In addition, some regulations directly address prices. Recently, Congress enacted the Credit Card Responsibility and Disclosure Act, which limits credit card rates and other fees.10 In March 2010, a massive healthcare overhaul bill known as the Affordable Care Act was enacted. The legislation, which took effect in 2013-2014, offers all Americans access to health care, including those with preexisting conditions who in the past have often been denied coverage.11 Government regulations create some problems in the international environment. In countries including Egypt, the Philippines, Thailand, Bangladesh, and Zimbabwe, to name a few, the government dictates prices for a range of products from bread to pharmaceuticals. Pricing regulations are enacted to maintain affordability of staple foods and goods, to prevent price gouging during shortages, and to slow inflation. When this kind of government control makes it impossible to produce their products and make a profit, a firm's only options are to use cheaper ingredients or not make their products available in that market. Consumer Trends Consumer trends also can strongly influence prices. Culture and demographics determine how consumers think and behave, so these factors have a large impact on all marketing decisions. One current consumer trend is referred to as the sharing economy in which consumers share goods and services with each other. Uber and Airbnb are examples of how consumers are sharing their assets while making some extra money from the service. We'll talk more about the sharing economy in Chapter 12. Another current consumer trend is saving time by buying time. More and more consumers choose to buy ready-made food, shop locally or online, enjoy "daycation" deals where hotels and spas offer access to a room or hotel amenities such as a pool for the day, and use digital timesaving devices such as robot vacuum cleaners. Consumers are also eating greener by cutting down on food waste, avoiding unhealthy food and overeating while eating local and seasonal food. Shopping for control is a response to the almost daily reports of terrorism and political unrest that have made the world a scary place for many consumers. This has led consumers to value products and services that provide some degree of predictability and control in an uncertain world. For example, consumers may install smart home technology or move to gated communities.12 The International Environment As we discussed in Chapter 2, the marketing environment often varies widely from country to country. This can have important consequences in developing pricing strategies. Can a company standardize prices for all global markets, or must it adjust to local conditions? For some products, such as jet airplanes, companies like Boeing and Airbus standardize their prices. This is possible, first, because about the only customers for the wide-bodies and other popular jets are major airlines and governments of countries that buy for their military or for use by government officials. Second, companies that build planes have little or no leeway to cut their costs without sacrificing safety. For other products, including most consumer goods, unique environmental factors in different countries mean that marketers must adapt their pricing strategies. As we noted in Chapter 2, the economic conditions in developing countries often mean that consumers simply cannot afford $3 or $4 or more for a bottle of shampoo or laundry detergent. As a result, marketers offer their brands at lower prices, often by providing them in one-use packages called sachets, which we discussed in Chapter 2. In other cases, companies must save on costs by using less expensive ingredients in their brands to provide toothpaste or soap that is affordable. Finally, channels of distribution often vary both in the types and sizes of available intermediaries and in the availability of an infrastructure to facilitate product distribution. Often these differences can mean that trade margins will be higher, as will the cost of getting the products to consumers.

legal issue in B2B pricing

Of course, illegal pricing practices are not limited to B2C pricing situations. Some of the more significant illegal B2B pricing activities include price discrimination, price fixing, and predatory pricing. Illegal B2B Price Discrimination The Robinson-Patman Act includes regulations against price discrimination in interstate commerce. Price discrimination regulations prevent firms from selling the same product to different retailers and wholesalers at different prices if such practices lessen competition. In addition to regulating the price companies charge, the Robinson-Patman Act specifically prohibits offering such "extras" as discounts, rebates, premiums, coupons, guarantees, and free delivery to some but not all customers. There are exceptions, however: The Robinson-Patman Act does not apply to products sold to consumers—only those sold to resellers. A discount to a large channel customer is legal if it is based on the quantity of the order and the resulting efficiencies, such as transportation savings. The act allows price differences if there are physical differences in the product, such as different features. A name-brand appliance may be available through a large national retail chain at a lower price than an almost identical item a higher-priced retailer sells because only the chain sells that specific model.

cross elasticity of demand

when changes in the price of one product affect the demand for another item

freemium pricing

a business strategy in which a product in its most basic version is provided free of charge but the company charges money (the premium) for upgraded versions of the product with more features, greater functionality, or greater capacity

cryptocurrency

a digital or virtual currency that uses cryptography for security

cash discounts

a discount offered to a customer to entice them to pay their bill quickly

break-even analysis

a method for determining the number of units that a firm must produce and sell at a given price to cover all its costs

cost-plus pricing

a method of setting prices in which the seller totals all the costs for the product and then adds an amount to arrive at the selling price

yield management pricing

a practice of charging different prices to different customers in order to manage capacity while maximizing revenues

demand-based pricing

a price-setting method based on estimates of demand at different prices

surge pricing

a pricing plan that raises prices of a product as demand goes up and lowers it as demand slides

peak load pricing

a pricing plan that sets prices higher during periods with higher demand

penetration pricing

a pricing strategy in which a firm introduces a new product at a very low price to encourage more customers to purchase it

value pricing or everyday low pricing (EDLP)

a pricing strategy in which a firm sets prices that provide ultimate value to customers

price leadership

a pricing strategy in which one firm first sets its price and other firms in the industry follow with the same or very similar prices

dynamic pricing

a pricing strategy in which the price can easily be adjusted to meet changes in the marketplace

prestige pricing or premium pricing

a pricing strategy used by luxury goods marketers in which they keep the price artificially high to maintain a favorable image of the product

decoy pricing

a pricing strategy where a seller offers at least three similar products; two have comparable but more expensive prices and one of these two is less attractive to buyers, thus causing more buyers to buy the higher priced more attractive item

uniform delivered pricing

a pricing tactic in which a firm adds a standard shipping charge to the price for all customers regardless of location

freight absorption pricing

a pricing tactic in which the seller absorbs the total cost of transportation

quantity discounts

a pricing tactic of charging reduced prices for purchases of larger quantities of a product

payment pricing

a pricing tactic that breaks up the total price into smaller amounts payable over time

target costing

a process in which firms identify the quality and functionality needed to satisfy customers and what price they are willing to pay before the product is designed; the product is manufactured only if the firm can control costs to meet the required price

high/low pricing

a retail pricing strategy in which the retailer prices merchandise at list price but runs frequent, often weekly, promotions that heavily discount some products

internal reference price

a set price or a price range in consumers' minds that they refer to in evaluating a product's price

internet price discrimination

an internet pricing strategy that charges different prices to different buyers for the same product based on order size or geographic location

trial pricing

pricing a new product low for a limited period of time in order to lower the risk for a customer

congestion pricing

pricing strategy of charging a high fee for operating cars during peak traffic times to reduce congestion

two-part pricing

pricing that requires two separate types of payments to purchase the product

prestige products

products that have a high price and that appeal to status-conscious consumers

affordable care act

provides access to health care for all Americans

wholesaler margin

the amount added to the cost of a product by a wholesaler

price

the assignment of value, or the amount the consumer must exchange to receive the offering

price-fixing

the collaboration of two or more firms in setting prices, usually to keep prices high

Vertical Integration

the combining of manufacturing operations with channels of distribution under a single ownership to reduce costs and increase profits

variable costs

the costs of production (raw and processed materials, parts, and labor) that are tied to and vary, depending on the number of units produced

contribution per unit

the difference between the price the firm charges for a product and the variable costs

retailer margin

the margin added to the cost of a product by a retailer

gross margin

the markup amount added to the cost of a product to cover the fixed costs of the retailer or wholesaler and leave an amount for a profit

price elasticity of demand

the percentage change in unit sales that results from a percentage change in price

market share

the percentage of a market (defined in terms of either sales units or revenue) accounted for by a specific firm, product lines, or brands

break-even point

the point at which the total revenue and total costs are equal and beyond which the company makes a profit; below that point, the firm will suffer a loss

price segmentation

the practice of charging different prices to different market segments for the same product

price lining

the practice of setting a limited number of different specific prices, called price points, for items in a product line

list price or MSRP

the price that the manufacturer sets as the appropriate price for the end consumer to pay

loss-leader pricing

the pricing policy of setting prices very low or even below cost to attract customers into a store

total costs

the total of the fixed costs and the variable costs for a set number of units produced

skimming price

a very high, premium price that a firm charges for its new, highly desirable product

10.1 what does it cost

10.1 Explain the importance of pricing and how marketers set objectives for their pricing strategies. "If you have to ask how much it is, you can't afford it!" We've all heard that, but how often do you buy something without asking the price? If price weren't an issue, we'd all drive dream cars, take trips to exotic places, and live like royalty. In the real world, though, most of us need to at least consider a product's price before we buy it. In the past two chapters, we've talked about creating and managing products. But to create value for customers, marketers must do more than just create a fantastic new (or existing) widget with all the bells and whistles consumers want. Equally (if not more) important is pricing the new offering so that consumers are willing to fork over their hard-earned cash to own the product. The question of what to charge for a product is a central part of the marketing plan. In this chapter, we'll tackle the basic question—what is price? We'll look at pricing objectives and the roles that demand, costs, revenues, and the environment play in the pricing decision process. Then, we'll explore specific pricing strategies and tactics. Finally, we'll look at the dynamic world of pricing on the Internet and at some psychological, legal, and ethical aspects of pricing. What Is Price? As we said in Chapter 1, price is the assignment of value, or the amount the consumer must exchange to receive the offering or product. Price, of course, has many names. We pay college tuition, rent for our apartment, interest on our credit card balance, a lawyer's or a doctor's professional fee, an insurance premium, a toll to use a road or a bridge, and a taxi, airplane, or bus fare. Payment may also be in the form of goods, services, favors, votes, or anything else that has value to the other party. Long before societies minted coins or printed paper money, people exchanged one good or service for another. This practice, called bartering, still occurs today. For example, someone who owns a home at a mountain ski resort may exchange a weekend stay for car repair or dental work. No money changes hands, but there still is an exchange of value (just ask the Internal Revenue Service). Other nonmonetary costs often are important to marketers. What is the cost of wearing seat belts? What is it worth to people to camp out in a clean national park? What does it cost to have cleaner air? To recycle? It is also important to consider an opportunity cost, or the value of something we give up to obtain something else. For example, the cost to obtain a college degree includes more than tuition; it also includes the income that the student could have earned by working instead of going to classes (no, we're not trying to make you feel guilty). And what about a public service campaign designed to reduce alcohol-related accidents? The cost to the individual is either agreeing to abstain and be a designated driver or shelling out for taxi or Uber fare. The value is reducing the risk of having a serious or possibly fatal accident. Unfortunately, too many people feel the chance of having an accident is so slim that the cost of abstaining from drinking is too high. Cryptocurrency The most recent addition to the value exchange is cryptocurrency, also known as digital currency. Cryptocurrencies are digital or virtual currencies that use cryptography for security. Digital currencies such as Ripple, Etherium, Litecoin, and Bitcoin are digital tokens with no physical backup. Note: Don't plan on walking around with a shiny new Bitcoin in your pocket; they don't really exist in the sense that you can touch or see one!1 While there are a number of different digital currencies, for now Bitcoin remains the most popular and the most valuable. Bitcoin's original popularity grew when in 2011, drug dealers began taking payments in this format. More recently, it has become a way to make ransom payments—for example, when a computer is taken over by ransomware. You can buy Bitcoin on several Bitcoin exchanges, or individuals can purchase them from each other using mobile apps that store their Bitcoins in a "virtual wallet." Today, most Bitcoin transactions are by people who speculate on the future prices of Bitcoin and hope to earn enormous returns in the future. A feature that makes Bitcoin and other digital currencies attractive to many around the globe is that it is organic. This means that it is not issued by any central authority. The entire records of the Bitcoin network are stored on every computer that helps to maintain the network—nearly 10,000 at the end of 2017. That is the feature that prevents cybercurrency such as Bitcoin from being controlled by any government or organization. This network of computers that maintains the database of all Bitcoin transactions is called the blockchain. There are distinct advantages to digital currency. For consumers, it eliminates the risk of credit card fraud that entices criminals to steal personal customer information and credit card numbers. To pay for your purchase, you use your smartphone to take a picture of the QR code displayed by the cash register. You click Confirm, and your app pays for your purchase.2 There is also a societal benefit from the use of digital currencies. Many lower-income consumers do not have bank accounts. Instead, they must often pay fees of 10 percent or higher each time they need to send a money order to a payee. With digital currency, such payments would cost only a fraction of that amount. Many believe that digital currencies will contribute to increased quality of life for those who live in the world's poorest countries. Digital currencies can be sent electronically anywhere in the world in a few minutes. That's good news for folks who need to make large international money transfers that would take weeks with traditional transfers going through banks—not to mention that you get the money back you loaned a friend right away! There are no "middlemen" (like banks) involved in the process that collect transaction fees (which is why many businesses like this option). However, it also means that transactions occur only from person to person, so there is no record of them, and this opens the potential for Bitcoins to show up in illegal transactions (such as funding terrorism or laundering drug money). While digital currency remains controversial, many believe that our future will be financed this way—in the long term, the world's banking system will be based on digital currency. Some people believe that within 10 years, Bitcoin or another cryptocurrency will be the only money in the world. But don't get rid of those dollars just yet! As Figure 10.1 shows, the elements of price planning include six steps: developing pricing objectives, estimating demand, determining costs, evaluating the pricing environment, choosing a pricing strategy, and developing pricing tactics. In this chapter, we talk about how marketers go through these steps for successful price planning.

sharing economy

A consumer activity where consumers share goods and services that is facilitated by an online platform.

Tax Cuts and Jobs Act of 2017

A major overhaul of personal and corporate taxes enacted by Congress in 2017.

uber

A peer-to-peer sharing service offering shared rides, food delivery, and transportation worldwide via websites and mobile apps.

step 3: determine costs

Estimating demand helps marketers to determine possible prices to charge for a product. It tells them how much of the product they think they'll be able to sell at different prices. Knowing this brings them to the third step in determining a product's price: making sure the price will cover costs. Before marketers can determine price, they must understand the relationship of cost, demand, and revenue for their product. In this next section, we'll talk about different types of costs that marketers must consider in pricing. Then, we'll show how marketers use that information to make pricing decisions. Variable and Fixed Costs It's obvious that the cost of producing a product plays a big role when firms decide what to charge for it. If an item's selling price is lower than the cost to produce it, it doesn't take a rocket scientist to figure out that the firm will lose money. Before we look at how cost influences pricing decisions, we need to understand the different types of costs that firms incur. First, a firm incurs variable costs—the per-unit costs of production that will fluctuate depending on how many units or individual products a firm produces. For example, if it takes 25 cents worth of nails—a variable cost—to build one bookcase, it will take 50 cents worth for two, 75 cents worth for three, and so on. Make cents? For the production of bookcases, variable costs would also include the cost of lumber and paint as well as the wages the firm would pay factory workers. Figure 10.8 shows some examples of the average variable cost (the variable cost per unit) and the total variable costs at different levels of production (for producing 100, 200, and 500 bookcases). If the firm produces 100 bookcases, the average variable cost per unit is $50, and the total variable cost is $5,000 ($50 × 100). If it doubles production to 200 units, the total variable cost now is $10,000 ($50 × 200). In reality, it's usually more complex to calculate variable costs than what we've shown here. As the number of bookcases the factory produces increases or decreases, average variable costs may change. For example, if the company buys just enough lumber for one bookcase, the lumberyard will charge top dollar. If it buys enough for 100 bookcases, the guys at the lumberyard will probably offer a better deal. And if it buys enough for thousands of bookcases, the company may cut variable costs even more. Even the cost of labor goes down with increased production because manufacturers are likely to invest in labor-saving equipment (a fixed cost) that allows workers to produce bookcases faster. Figure 10.8 shows this is the case. By purchasing wood, nails, and paint at a lower price (because of a volume discount) and by providing a means for workers to build bookcases more quickly, the company reduces the cost per unit to produce 500 bookcases to $40 each. Variable costs don't always go down with higher levels of production. Using the bookcase example, at some point the demand for the labor, lumber, or nails required to produce the bookcases may exceed the supply: The bookcase manufacturer may have to pay employees higher overtime wages to keep up with production. The manufacturer may have to buy additional lumber from a distant supplier that will charge more to cover the costs of shipping. The cost per bookcase rises. You get the picture. Fixed costs are costs that do not vary with the number of units produced—the costs that remain the same whether the firm produces 1,000 bookcases this month or only 10. Fixed costs include rent or the cost of owning and maintaining the factory; utilities to heat or cool the factory; equipment, such as saws, hammers, and other hand tools; a sophisticated assembly line; robotics; and paint sprayers used in the production of the product. Although the wages of factory workers to build the bookcases are part of a firm's variable costs, the salaries of a firm's executives, accountants, human resources specialists, marketing managers, and other personnel not involved in the production of the product are fixed costs. So too are other costs, such as advertising and other marketing activities, at least in the short term. All these costs are constant no matter how many units of the product the factory manufactures. Average fixed cost is the fixed cost per unit—the total fixed costs divided by the number of units (bookcases) produced and sold. Although total fixed costs remain the same no matter how many units are produced, the average fixed cost will decrease as the number of units produced increases. Say, for example, that a firm's total fixed costs of production are $300,000. If the firm produces one unit, it applies the total of $300,000 to the one unit. If it produces two units, it applies $150,000, or half of the fixed costs, to each unit. If it produces 10,000 units, the average fixed cost per unit is $30 and so on. As we produce more and more units, average fixed costs go down, and so does the price we must charge to cover fixed costs. Of course, like variable costs, in the long term, total fixed costs may change. The firm may find that it can sell more of a product than it has manufacturing capacity to produce, so it builds a new factory, its executives' salaries go up, and more money goes to purchase manufacturing equipment. Combining variable costs and fixed costs yields total costs for a given level of production. As a company produces more and more of a product, both average fixed costs and average variable costs may decrease. Then, output may continue to increase, requiring the organization to pay its workers overtime or higher salaries, and/or to pay more for materials such as the lumber used in our bookcase example. In this case, the average variable costs may start to increase. If these variable costs ultimately rise faster than average fixed costs decline, this will result in an increase to average total costs. Similarly, increasing production may mean increased fixed costs. As total costs fluctuate with differing levels of production, the price that producers have to charge to cover those costs changes accordingly. Therefore, marketers need to calculate the minimum price necessary to cover all costs—the break-even price. Break-Even Analysis Break-even analysis is a metric marketers use to examine the relationship between costs and price. This method lets them determine what sales volume the company must reach at a given price before it will completely cover its total costs and past which it will begin to turn a profit. Simply put, the break-even point is the point at which the company doesn't lose any money and doesn't make any profit. All costs are covered, but there isn't a penny extra. A break-even analysis allows marketers to identify how many units of a product they will have to sell at a given price to exceed the break-even point and be profitable. Figure 10.9 uses our bookcase example to demonstrate break-even analysis assuming the manufacturer charges $100 per unit. The vertical axis represents the amount of costs and revenue in dollars, and the horizontal axis shows the quantity of goods the manufacturer produces and sells. The break-even model assumes that there is a given total fixed cost and that variable costs per unit do not change with the quantity produced. In this example, let's say that the total fixed costs (the costs for the factory, equipment, marketing, and electricity) are $200,000 and that the average variable costs (for materials and labor) are constant. The figure shows the total costs (variable costs plus fixed costs) and total revenues if varying quantities are produced and sold. The point at which the total revenue and total costs lines intersect is the break-even point. If sales are above the break-even point, the company makes a profit. Below that point, the firm will suffer losses. To determine the break-even point, the firm first needs to calculate the contribution per unit, or the difference between the price the firm charges for a product (the revenue per unit) and the variable costs. This figure is the amount the firm has after it pays for the wood, nails, paint, and labor to contribute to meeting the fixed costs of production and any profit. For our example, we will assume that the firm sells its bookcases for $100 each. Using the variable costs of $50 per unit that we had before, contribution per unit is the selling price (SP) minus the variable costs (VC)—in this case, (VC)—Using the fixed cost for the bookcase manufacturing of $200,000, we can now calculate the firm's break-even point in units of the product: Break-even point (in units)Break-even point (in units)Break-even point (in units)===Total fixed costsContribution per unit to fixed costsTotal fixed costs(SP−VC)$200,000$50=4,000 units Break-even point (in units)=Total fixed costsContribution per unit to fixed costsBreak-even point (in units)=Total fixed costs(SP−VC)Break-even point (in units)=$200,000$50=4,000 units We see that the firm must sell 4,000 bookcases at $100 each to meet its fixed costs and to break even. We can also calculate the break-even point in dollars. This shows us that to break even, the company must sell $400,000 worth of bookcases: Break-even point (in dollars)Break-even point (in dollars)==Total fixed costs1−Variable cost per unitSelling price200,0001−$50$100=$200,0001−0.5=$200,0000.5=$400,000 Break-even point (in dollars)=Total fixed costs1−Variable cost per unitSelling priceBreak-even point (in dollars)=200,0001−$50$100=$200,0001−0.5=$200,0000.5=$400,000 After the firm's sales have met and passed the break-even point, it begins to make a profit. How much profit? If the firm sells 4,001 bookcases, it will make a profit of $50. If it sells 5,000 bookcases, we calculate the profit as follows: Profit===Quantity above break-even point×Contribution per unit1,000×$50$50,000 Profit=Quantity above break-even point×Contribution per unit=1,000×$50=$50,000 Often a firm will set a profit goal, the dollar profit figure it wants to earn. Its managers may calculate the break-even point with a certain dollar profit goal in mind. In this case, it is not really a "break-even" point we are calculating because we're seeking profits. It's more of a "target amount." If our bookcase manufacturer thinks it is necessary to realize a profit of $50,000, his calculations look like this: Break-even point (in units) with target profit includedBreak-even point (in unit) unit target profit included==Total fixed costs+Target profitContribution per unit to fixed costs$200,000+50,000$50=5,000 units Break-even point (in units) with target profit included=Total fixed costs+Target profitContribution per unit to fixed costsBreak-even point (in unit) unit target profit included=$200,000+50,000$50=5,000 units Knowing the break-even point is equally important to small or large businesses. The owner of a restaurant that is already meeting its fixed costs and making a profit knows that if he can increase his sales, the contribution margin portion of all new sales will be profit. If an automaker can cut its costs by obtaining component parts for a lower price, the contribution margin and profits will increase with no increase in sales. This is the reason many U.S. firms have moved overseas where labor costs are lower or where governments have lower corporate tax rates. Because of significant changes made by the The Tax Cuts and Jobs Act of 2017 (TCJA of 2017) to the way that domestic businesses are taxed on overseas earnings, the hope/expectation is that these changes will result in companies returning jobs/investment to the U.S. Break-even analysis does not provide an easy answer for pricing decisions. Yes, it provides answers about how many units the firm must sell to break even and to make a profit, but without knowing whether demand will equal that quantity at that price, companies can make big mistakes. Markups and Margins: Pricing through the Channel So far, we've talked about costs simply from the perspective of a manufacturer selling directly to a consumer. But in reality, most products are not sold directly to consumers or business buyers. Instead, a manufacturer may sell a consumer good to a wholesaler, distributor, or jobber who in turn sells to a retailer who finally sells the product to the ultimate consumer. In organizational markets, the manufacturer may sell his or her product to a distributor who will then sell to the business customer. Each of these members of the channel of distribution buys a product for a certain amount and adds a markup amount to create the price at which they will sell a product. This markup amount is the gross margin, also referred to as the retailer margin or the wholesaler margin when discussing pricing through the channel of distribution. The margin must be great enough to cover the fixed costs of the retailer or wholesaler and leave an amount for a profit. When a manufacturer sets a price, he or she must consider these margins. To understand pricing through the channel better, Figure 10.10 shows a simple example of channel pricing. Many times, a manufacturer builds its pricing structure around list prices. A list price, which we also refer to as a manufacturer's suggested retail price (MSRP), is the price that the manufacturer sets as the appropriate price for the end consumer to pay. In Figure 10.10 we have a consumer good with an MSRP of $20, the price that the retailers will charge a consumer. But, as we said, retailers need money to cover their fixed costs and their profits. Thus, the retailer may determine that he must have a certain percentage gross or retailer margin—in this case, 30 percent. This means that the retailer must be able to buy the product for $14 or less. If the channel of distribution also includes a wholesaler or distributor, the wholesaler/distributor must be able to mark up the product to pay their fixed costs and profits. This means that the wholesaler must also have a certain percentage gross or wholesaler margin—in our example, 20 percent. This means that the wholesaler must be able to buy the product for $11.20 or less to cover his fixed costs and profits. Thus, the manufacturer will sell the product not for $20 but for $11.20. Of course, the manufacturer may sell the product to the wholesaler for less than that, but he cannot sell it for more and meet the margin requirements of the retailer and the wholesaler. If the manufacturer's variable costs for producing the product are $7.85, then his contribution to fixed costs is $11.20-$7.85, or $3.35. This is the manufacturer's contribution and the amount that would be used to calculate the break-even point. Many retail organizations or chains such as Walmart, Walgreens Drug Stores, and Kroger Supermarkets have found that it makes good sense to handle the tasks of the wholesaler themselves through vertical integration. This means these retail chains have their own distribution centers and move products to stores in their own trucks, thus saving money while maintaining greater control over the availability and delivery of products to their stores. Hopefully, they are able to offer lower prices to their consumers. We'll talk more about these vertical marketing systems in Chapter 11.

bottom of the pyramid pricing

Innovative pricing strategy in which brands that wish to get a foothold in bottom-of-the-pyramid countries appeal to consumers with the lowest incomes.

online auctions

Most consumers are familiar with eBay. But what about eCrater, Bonanzle, eBid, and CQout? These too are some of the many online auctions that allow shoppers to bid on everything from bobbleheads to health-and-fitness equipment to a Sammy Sosa home-run ball. Auctions are a powerful Internet pricing strategy. Perhaps the most popular auctions are the C2C auctions such as those on eBay. The eBay auction is an open auction, meaning that all the buyers know the highest price bid at any point in time. On many Internet auction sites, the seller can set a reserve price, a price below which the item will not be sold. A reverse auction is a tool firms use to manage their costs in B2B buying. Although in a typical auction, buyers compete to purchase a product, in reverse auctions sellers compete for the right to provide a product at, the buyers hope, a low price.

step 6: develop pricing tactics

Once marketers have developed pricing strategies, the last step in price planning is to implement them. The methods companies use to set their strategies in motion are their pricing tactics. Pricing for Individual Products Pricing tactics, the way marketers present a product's price, can make a big difference in the success of the product: Two-part pricing requires two separate types of payments to purchase the product. For example, golf and tennis clubs charge yearly or monthly fees plus fees for each round of golf or tennis. Payment pricing makes the consumer think the price is "do-able" by breaking up the total price into smaller amounts payable over time. For example, Home Shopping Network (HSN) offers payment pricing for many of its products. You might buy a UHD Smart TV for a single price of over $1,000 or 6 FlexPay of less than $200. The payment price sounds much better than forking over a thousand dollars at one time! Decoy pricing is a strategy where a seller offers at least three similar products. Two of them have comparable but more expensive prices than the third, and one of these two is less attractive to buyers than the other. The result is that people will more often choose the more attractive of the two higher-priced items. As an example, think about an electronics retailer who would like for his customers to buy a specific, higher-priced laptop with a higher margin that will mean more profits for him. With decoy pricing, he will offer three different laptops—we'll call them models A, B, and C. Model A is a stripped-down, no-name brand laptop, much lower priced than either model B or model C, and unlikely to attract many sales. One of the two higher-priced items, say model B, has a larger hard drive, superior screen resolution and more RAM than model C. In this case, model C is the decoy. When consumers compare it to model B, they will naturally buy model B, just as the retailer wanted them to do. Pricing for Multiple Products A firm may sell several products that consumers typically buy at one time. As fast-food restaurants like Burger King know, a customer who buys a burger for lunch usually springs for a soft drink and fries as well. The purchase of a single-serve coffee brewer means you also need to purchase lots of K-cup coffee pods. The two most common tactics for pricing multiple products are price bundling and captive pricing. Price bundling means selling two or more goods or services as a single package for one price—a price that is often less than the total price of the items if bought individually. Traditional cable TV providers, like AT&T U-verse, Comcast Xfinity, and Spectrum, have gotten into the price bundling act as they entice their customers to sign on for a package of cable TV, high-speed Internet, and local or, in some cases, wireless phone service. From a marketing standpoint, price bundling makes sense. If we price products separately, it's more likely that customers will buy some but not all the items. They might choose to put off some purchases until later, or they might buy from a competitor. Whatever revenue a seller loses from the reduced prices for the total package, it often makes up for in increased total purchases. Captive pricing is a pricing tactic a firm uses when it has two products that work only when used together. The firm sells one item at a very low price and then makes its profit on the second high-margin item. This tactic is commonly used to sell shaving products where the razor is relatively cheap but the blades are not. Similarly, companies such as HP and Canon offer consumers a desktop printer that also serves as a fax, copier, and scanner for under $100 to keep selling the very high-priced ink cartridges. Distribution-Based Pricing Distribution-based pricing is a pricing tactic that establishes how firms handle the cost of shipping products to customers near, far, and wide. Characteristics of the product, the customers, and the competition figure in the decision to charge all customers the same price or to vary according to shipping cost. F.O.B. pricing is a tactic business-to-business (B2B) marketers use. F.O.B. stands for free on board, which refers to who pays for the shipping. Also—and this is important—title passes to the buyer at the F.O.B. location. F.O.B. factory pricing, or F.O.B. origin pricing, means that the cost of transporting the product from the factory to the customer's location is the responsibility of the customer. F.O.B. delivered pricing means that the seller pays both the cost of loading and the cost of transporting to the customer, amounts it added into the selling price. Delivery terms for pricing of products sold in international markets are similar:22 CIF (cost, insurance, freight) is the term used for ocean shipments and means the seller quotes a price for the goods (including insurance), all transportation, and miscellaneous charges to the point of debarkation from the vessel. CFR (cost and freight) means the quoted price covers the goods and the cost of transportation to the named point of debarkation, but the buyer must pay the cost of insurance. The CFR term is also used for ocean shipments. CIP (carriage and insurance paid to) and CPT (carriage paid to) include the same provisions as CIF and CFR but are used for shipment by modes other than water. When a firm uses uniform delivered pricing, it adds a preset shipping cost to the price, no matter what the distance from the manufacturer's plant—within reason. Uniform delivered pricing is most likely to be used when shipping charges are very low. For example, when you order the latest Harry Potter book, you may pay the cost of the book plus $3.99 for shipping and handling, no matter what the actual cost of the shipping to your particular location. Internet sales, catalog sales, home TV shopping, and other types of nonstore retail sales usually use uniform delivered pricing. Freight absorption pricing means the seller takes on part or all of the cost of shipping. This policy works well for high-ticket items, for which the cost of shipping is a negligible part of the sales price and the profit margin. Marketers are most likely to use freight absorption pricing in highly competitive markets or when such pricing allows them to enter new markets. Online marketers such as Amazon.com have found that offering free shipping makes a big difference to consumers and to their sales volume. Even traditional big-box retailers are getting in on the trend—Target recently announced free two-day shipping on any size order for its REDcard holders.23 Discounting for Channel Members So far, we've talked about pricing tactics used to sell to end customers. Now we'll talk about tactics firms use to price to members of their distribution channels: Trade or functional discounts: We discussed previously how manufacturers often set a list or suggested retail price for their product and then sell the product to members of the channel for less, allowing the channel members to cover their costs and make a profit. Thus, the manufacturer's pricing structure will normally include trade discounts to channel intermediaries. These discounts are usually set percentage discounts off the suggested retail or list price for each channel level. In today's marketing environment dominated by large retail chains such as Walmart, Costco, and Target, the retailers dictate the amount of the trade discount, and the larger their size, the more power they have in the channel. We'll talk more about channel power in Chapter 11. Quantity discounts: To encourage larger purchases from distribution channel partners or from large organizational customers, marketers may offer quantity discounts, or reduced prices for purchases of larger quantities. Cumulative quantity discounts are based on a total quantity bought within a specified time period, often a year, and encourage a buyer to stick with a single seller instead of moving from one supplier to another. Cumulative quantity discounts often take the form of rebates, in which case the firm sends the buyer a rebate check at the end of the discount period or, alternatively, gives the buyer credit against future orders. Noncumulative quantity discounts are based only on the quantity purchased with each individual order and encourage larger single orders but do little to tie the buyer and the seller together. Cash discounts: Many firms try to entice their customers to pay their bills quickly by offering cash discounts. For example, a firm selling to a retailer may state that the terms of the sale are "2 percent 10 (days), net 30 (days)," meaning that if the retailer or organizational customer pays the producer for the goods within 10 days, the amount due is cut by 2 percent. The total amount is due within 30 days, and after 30 days, the payment is late. Seasonal discounts: Seasonal discounts are price reductions offered only during certain times of the year. For seasonal products such as snow blowers, lawn mowers, and water-skiing equipment, marketers use seasonal discounts to entice retailers and wholesalers to buy off-season and either store the product at their locations until the right time of the year or pass the discount along to consumers with off-season sales programs. Alternatively, they may offer discounts when products are in season to create a competitive advantage during periods of high demand.

competitive-effect pricing, market-based pricing

Pricing a product based on (above, below, or the same as) the competition's pricing.

psychological pricing strategies

Setting a price is part science, part art. Marketers must understand psychological responses to prices when they decide what to charge for their goods or services. Odd-Even Pricing In the U.S. market, we usually see prices in dollars and cents—$1.99, $5.98, $23.67, or even $599.95. We see prices in even dollar amounts—$2, $10, or $600—far less often. The reason? Marketers assume that there is a psychological response to odd prices that differs from the response to even prices. Habit might also play a role here. Whatever the reason, research shows that prices ending in 99 rather than 00 can increase sales by 21-34 percent, depending on other factors. That's a huge amount of sales, so it's no surprise that 60 percent of U.S. prices end in a 9.33 But there are some instances in which even prices are the norm or perhaps a necessity. Theater and concert tickets, admission to sporting events, and lottery tickets tend to be priced in even amounts. Professionals normally quote their fees in even dollars. Would you want to visit a doctor or dentist who charged $39.99 for a visit, or would you be concerned that the quality of medical care was less than satisfactory? Many luxury items, such as jewelry, golf course fees, and resort accommodations, use even dollar prices to set them apart. Restaurants (and the menu engineers who work with them) have discovered that how prices for menu items are presented has a major influence on what customers order—and how much they pay. When prices are given with dollar signs or even the word dollar, customers spend less. Thus, a simple 9 is better on a menu than $9. For high-end restaurants, the formats that end in 9, such as $9.99, indicate value but not quality.34 Price Lining Marketers often apply their understanding of the psychological aspects of pricing in a practice they call price lining, whereby items in a product line sell at different prices, or price points. If you want to buy a new digital camera, you will find that most of the leading manufacturers have one "stripped-down" model for $100 or less. A better-quality but still moderately priced model likely will be around $200, whereas a professional-quality camera with multiple lenses might set you back $1,000 or more. Another great example can be found at your local car wash! Typically, customers are able to select from one of several package options—the lower-priced choices offering a basic wash, while the higher-end packages include extras like a hot wax or wheel detail. Price lining provides the different ranges necessary to satisfy each segment of the market. Why is price lining a smart idea? From the marketer's standpoint, it's a way to maximize profits. In theory, a firm would charge each individual customer the highest price that customer is willing to pay. If the maximum one particular person is willing to pay for a digital camera is $150, then that will be the price. If another person is willing to pay $300, that will be his price. But charging each consumer a different price is really not possible. Having a limited number of prices that generally fall at the top of the different price ranges that customers find acceptable is a more workable alternative. Prestige or Premium Pricing Finally, although a "rational" consumer should be more likely to buy a product or service as the price goes down, in the real world, this assumption sometimes gets turned on its head. Remember that previously in the chapter we talked about situations where we want to meet an image-enhancement objective to appeal to status-conscious consumers. For this reason, sometimes luxury goods marketers use prestige pricing, or premium pricing, in which they keep the price of the product artificially high to maintain a favorable image of the product based on price only. Prestige pricing relies on the price-quality inference that we talked about before. Tumi, a luxury luggage maker, began cutting promotional activity in 2014 to protect the premium nature of the brand. Their high-end price point is targeted specifically at the upscale business traveler.35 Contrary to the "rational" assumption that we are more likely to purchase a product or service as the price goes down, in these cases, believe it or not, people tend to buy more as the price goes up!

Pricing Advantages for Online Shoppers

The Internet also creates unique pricing challenges for marketers as consumers and business customers gain more control over the buying process. Access to sophisticated "shopbots" and search engines means that consumers are no longer at the mercy of firms that dictate a price they must accept. The result is that customers have become more price sensitive. Many computer-savvy Internet shoppers find that shopbots provide them with the best price on all kinds of products. As one illustration, a comparison study found that the price of an Otter Box Defender Series iPhone case ranged from a high of $59.90 at OtterBox.com to a low of $44.20 at Amazon.com. Similarly, the price of a Michael Kors Signature Tote is $165.50 at Amazon.com but $198.00 online from Nordstrom (no, we're not working on commission). Detailed information about what products actually cost manufacturers, available from sites such as Consumerreports.org, can give consumers more negotiating power when shopping for new cars and other big-ticket items. Finally, e-commerce potentially can lower consumers' costs because of the gasoline, time, and aggravation they save when they avoid a trip to the mall.

blockchain

The network of computers that maintains the database of all Bitcoin and other digital currency transactions.

step 1: develop pricing objectives

The first crucial step in price planning is to develop pricing objectives. These must support the broader objectives of the firm, such as maximizing shareholder value, as well as its overall marketing objectives, such as increasing market share. Figure 10.2 provides examples of different types of pricing objectives. Let's take a closer look at these. Profit Objectives As we discussed in Chapter 2, often a firm's overall objectives relate to a certain level of profit it hopes to realize. When pricing strategies are determined by profit objectives, the focus most often is on a target level of profit growth or a desired net profit margin. A profit objective is important to firms that believe profit is what motivates shareholders and bankers to invest in a company. Because firms usually produce an entire product line or a product mix, profit objectives may focus on pricing for the firm's entire portfolio of products. In such cases, marketers develop pricing strategies that maximize the profits of the entire portfolio rather than focusing on the costs or profitability of each individual product. For example, it may be better to price one product especially high and lose sales on it if that decision causes customers to instead purchase a product that has a higher profit margin. That's why many retail chains are happy if you buy their own store brand. While the store brand is a lower cost to you, the retailer may sell the product for 35 or 40 percent more than they pay for it, while with the national brand, the price has only a 30 percent markup on their cost. We'll talk more about markups a little later in this chapter. Although profits are an important consideration in the pricing of all goods and services, they are critical when the product is a fad. Hula hoops and poodle skirts were popular fads in the 1950s, mopeds and Pet Rocks in the 1970s, and Beanie Babies, the Furby, and rollerblades in the 1990s. Today's fads include cronuts, yoga pants, the Duck Dynasty and Honey Boo Boo TV shows, cryotherapy (where you spend three minutes in a chamber where the temperature is between minus 230 and minus 300 degrees), and eating Tide pods (yes, really!). Because fads such as these have a very short market life (and your life will be pretty short if you eat those Tide pods), the profit objective is essential to allow the firm to recover its investment in a short time. In such cases, the firm must harvest profits before customers lose interest and move on to the next cool idea. Sales or Market Share Objectives Often the objective of a pricing strategy is to maximize sales (either in dollars or in units) or to increase market share. Does setting a price intended to increase unit sales or market share simply mean pricing the product lower than the competition? Sometimes, yes. Providers of cable and satellite TV services, such as Spectrum, Xfinity, DIRECTV, and AT&T U-verse, relentlessly offer consumers better deals that include more TV, wireless Internet, and telephone service. But lowering prices is not always necessary to increase market share. If a company's product has a competitive advantage, keeping the price at the same level as other firms may satisfy sales objectives. And such "price wars" can have a negative effect when consumers switch from one producer to another simply because the price changes. Competitive Effect Objectives Sometimes strategists design the pricing plan to dilute the competition's marketing efforts. In these cases, a firm may deliberately try to preempt or reduce the impact of a rival's pricing changes. This is referred to as competitive-effect pricing, or market-based pricing. Generally, all airlines offer the exact or almost the same prices for the routes they fly. That is, until low-cost carriers such as Spirit or Frontier Airlines move in. That's what happened when these two airlines moved into Philadelphia and the cost of the one-way fare between Detroit and Philadelphia went from over $300 to $183 on all carriers, including Delta Air Lines and American Airlines.3 Metrics Moment One criticism of marketing is that it lags behind other business areas in terms of measuring performance and what and how much it contributes to the success of the overall business. In fact, for most of marketing's history as a field, simple sales volume response (in currency or units) to marketing expenditures was the most frequently cited metric. But, of course, many factors influence sales volume, so it is hard for marketing to claim a direct one-to-one relationship between marketing effectiveness and increases in sales. Market share is the percentage of a market (defined in terms of either sales units or revenue) accounted for by a specific firm, product lines, or brands. Market share is quoted within the context of a particular set of competitors.4 For example, out of the set of global auto manufacturers (which is only a few firms) one firm might claim a market share of 18 percent based on revenue globally but 9 percent in the U.S. In truth, market share is often a "bragging right" for a firm—sort of a "We're number one!" cheer. But some strategy gurus question whether a market share number is actually very useful as a marketing performance metric because there are numerous cases in which firms, product lines, or brands that do not have number one bragging rights in market share are consistently more profitable than their higher-share competitors. Why would this be? This chapter on pricing provides you with many insights that can help tell the full story. Apply the Metrics Pick any industry and identify the main competitors—this can be any type of product or service line of your choice as long as there are several easily identified competing brands. (Hint: Publicly traded firms are easier to research than privately held firms.) Do a little research to find out how their market shares stack up. If there are a lot of competitors, limit your list to the top four to five. Then, for the same firms, take a look at their most recent reported profits. Based on your findings, does a higher market share translate into a better profit picture? Customer Satisfaction Objectives Many quality-focused firms believe that profits result from making customer satisfaction their primary objective. These firms believe that if they focus solely on short-term profits, they will lose sight of their objective to retain customers for the long term that we discussed in Chapter 1. Retail giant Walmart, long known as the "everyday low price" leader, hopes to make its customers even more satisfied with its pricing. Following the lead of stores like Target and Best Buy that offer to meet the lower prices of their rivals, Walmart introduced Savings Catcher, a tool within its mobile app that customers can use to ensure they're getting the lowest price on more than 80,000 food and household products when compared to the advertised prices of those of the competitors in the same geographic area. Customers need only scan the receipt with the Walmart phone app and the Savings Catcher tool will automatically compare the prices on the receipt with the advertised prices at other local stores. Savings are returned to the customer in the form of an e-gift card that can be used for future Walmart purchases.5 Of course, Walmart is not the only retailer that seeks to be known for its customer satisfaction and sets prices accordingly. The American Customer Satisfaction Index (ACSI®) Retail Report 2017 showed that top scores in customer satisfaction for their category included Publix (supermarkets); a tie between Kmart and Kroger (health and personal care); L Brands, owner of Victoria's Secret, Bath & Body Works, and PINK (specialty retail stores); and Costco (department and discount stores).6 Image Enhancement Objectives Consumers often use price to make inferences about the quality of a product. In fact, marketers know that price is often an important means of communicating not only quality but also image to prospective customers. The image-enhancement function of pricing is particularly important with prestige products (or luxury products) that have a high price and appeal to status-conscious consumers. Most of us would agree that the high price tag on a Rolex watch, a Louis Vuitton handbag, or a Rolls-Royce car, although representing the higher costs of producing the product, is vital to shaping an image of an extraordinary product that only the wealthy can afford (not counting the "real" Rolex you buy for $10 from that shady guy on the street). From the iPhone's introduction, Apple has used prestige pricing to ensure an image of a premium brand that is a more refined and polished alternative compared to cheaper smartphones. The company also applied this strategy when it introduced the iPhone X with its infrared facial recognition and wireless charging in 2017 at a price of around $1,000. That price was way above the $769 minimum for the previous top iPhone and the iPhone 7 Plus, and as much as the entry-level MacBook Air laptop.7

legal and ethical considerations in B2C pricing

The free enterprise system is founded on the idea that the marketplace will regulate itself. Prices will rise or fall according to demand. Firms and individuals will supply goods and services at fair prices if there is an adequate profit incentive. Unfortunately, the business world includes the greedy and the unscrupulous. Deceptive Pricing Practices: Bait and Switch Unscrupulous businesses may advertise or promote prices in a deceptive way. The Federal Trade Commission (FTC), state lawmakers, and private bodies such as the Better Business Bureau have developed pricing rules and guidelines to meet the challenge. They say retailers (or other suppliers) must not claim that their prices are lower than a competitor's unless that claim is true. A going-out-of-business sale should be the last sale before going out of business. A fire sale should be held only when there really was a fire. Another deceptive pricing practice is the bait-and-switch tactic, whereby a retailer will advertise an item at a very low price—the bait—to lure customers into the store. An example might be a budget model TV that has been stripped of all but the most basic features. But it is almost impossible to buy the advertised item—salespeople like to say (privately) that the item is "nailed to the floor." The salespeople do everything possible to get the unsuspecting customers to buy a different, more expensive item—the switch. They might tell the customer "confidentially" that "the advertised item is really poor quality, lacking important features, and full of problems." It's complicated to enforce laws against bait-and-switch tactics because these practices are similar to the legal sales technique of "trading up." Simply encouraging consumers to purchase a higher-priced item is acceptable, but it is illegal to advertise a lower-priced item when it's not a legitimate, bona-fide offer that is available if the customer demands it. Another example of a bait-and switch tactic is hotels that lure consumers in with extremely low room rates and then at booking slap on many additional fees and surcharges that sometimes double the advertised price of the room.36 The FTC may determine if an ad is a bait-and-switch scheme or a legitimate offer by checking to see if a firm refuses to show, demonstrate, or sell the advertised product; disparages it; or penalizes salespeople who do sell it. Loss-Leader Pricing and Unfair Sales Acts Not every advertised bargain is a bait and switch. Some retailers advertise items at very low prices or even below cost and are glad to sell them at that price because they know that once in the store, customers may buy other items at regular prices. Marketers call this loss-leader pricing; they do it to build store traffic and sales volume. For example, grocery stores know that a sale on chicken is sure to pack the aisles, and they are banking on the fact that while you are in the store, you will fill your cart with many other items you need, at regular price.37 These retailers use loss-leader pricing—boneless, skinless chicken breasts for $2.98/lb.—to get you to choose their store for your weekly shopping. In the same way, you can buy markers, glue, and other school supplies in July and August for less than half of what it is at other times of the year. Some states frown on loss-leader practices, so they have passed legislation called unfair sales acts (also called unfair trade practices acts). These laws or regulations prohibit wholesalers and retailers from selling products below cost. These laws aim to protect small wholesalers and retailers from larger competitors because the "big fish" have the financial resources that allow them to offer loss leaders or products at very low prices—they know that the smaller firms can't match these bargain prices. Meijer, a Michigan-based grocer, was accused of violating a Depression-era law in Wisconsin. Several complaints were filed, citing 37 products that were being sold at less than cost, including ice cream, tomatoes, and bananas.38 Misleading Merchandising Sometimes, the merchandising activities in the retail store are deceptive or at least suspicious. Consumers assume that items in an end-aisle display are being sold at a discounted price. When retailers display regularly priced merchandise in these displays, they may be accused of taking advantage of consumers. Consumers also assume that the larger bottle or box of something is a better deal. Not always true! Although government regulations now require that grocers and other retailers of food post the price per ounce, pound, and such, on store shelves, few consumers seem to look at these labels.

FOB delivered pricing

a pricing tactic in which the cost of loading and transporting the product to the customer is included in the selling price and is paid by the manufacturer

F.O.B. factory pricing, or F.O.B. origin pricing

a pricing tactic in which the cost of transporting the product from the factory to the customer's location is the responsibility of the customer

markup

an amount added to the cost of a product to create the price at which a channel member will sell the product

bait and switch

an illegal marketing practice in which an advertised price special is used as bait to get customers into the store with the intention of switching them to a higher-priced item

predatory pricing

an illegal pricing strategy in which a company sets a very low price for the purpose of driving competitors out of business

shopping for control

consumers, facing a world with terrorism and political unrest, value products and services that provide some degree of control, such as installing smart home technology or moving to gated communities

fixed costs

costs of production that do not change with the number of units produced

elastic demand

demand in which changes in price have large effects on the amount demanded

inelastic demand

demand in which changes in price have little or no effect on the amount demanded

trade discounts

discounts off list price of products to members of the channel of distribution who perform various marketing functions

online auction

e-commerce that allows shoppers to purchase products through online bidding

Credit Card Responsibility and Disclosure Act

limits credit card rates and other fees

seasonal discounts

price reductions offered only during certain times of the year

keystoning

retail pricing strategy in which the retailer doubles the cost of the item (100 percent markup) to determine the price

price bundling

selling two or more goods or services as a single package for one price

unfair sales acts

state laws that prohibit suppliers from selling products below cost to protect small businesses from larger competitors

average fixed cost

the fixed cost per unit produced

bitcoin

the most popular and fastest-growing digital currency

10.2 costs, demand, revenue, and the pricing environment

10.2 Describe how marketers use costs, demand, revenue, and the pricing environment to make pricing decisions. Once a marketer decides on its pricing objectives, it is time to begin the actual process of price setting. To set the right price, marketers must understand a variety of quantitative and qualitative factors that can mean success or failure for the pricing strategy. As Figure 10.3 shows, these include an estimate of demand, knowledge of costs and revenue, and an understanding of the pricing environment. Step 2: Estimate Demand The second step in price planning is to estimate demand. Demand refers to customers' desire for a product: How much of a product are they willing to buy as the price of the product goes up or down? Obviously, marketers should know the answer to this question before they set prices. Therefore, one of the earliest steps marketers take in price planning is to estimate demand for their products. Demand Curves Economists use a graph of a demand curve to illustrate the effect of price on the quantity demanded of a product. The demand curve, which can be a curved or straight line, shows the quantity of a product that customers will buy in a market during a period of time at various prices if all other factors remain the same. Figure 10.4 shows demand curves for normal and prestige products. The vertical axis for the demand curve represents the different prices that a firm might charge for a product (P). The horizontal axis shows the number of units or quantity (Q) of the product demanded. The demand curve for most goods (that we show on the left side of Figure 10.4) slopes downward and to the right. As the price of the product goes up (P1 to P2), the number of units that customers are willing to buy goes down (Q1 to Q2). If prices decrease, customers will buy more. This is the law of demand. For example, if the price of bananas goes up, customers will probably buy fewer of them. And if the price gets really high, customers will eat their cereal without bananas. There are, however, exceptions to this typical price-demand relationship. In fact, there are situations in which (otherwise sane) people desire a product more as it increases in price. For prestige products such as luxury cars or jewelry, a price hike may actually result in an increase in the quantity consumers demand because they see the product as more valuable. In such cases, the demand curve slopes upward. The right-hand side of Figure 10.4 shows the "backward-bending" demand curve we associate with prestige products. If the price increases, consumers perceive the product to be more desirable and demand is likely to increase. You can see that if the price increases from P3 to P2, the quantity demanded increases from Q1 to Q2. On the other hand, if the price decreases, consumers think the product is less desirable. This is what happens if the price begins at P2 and then goes up to P3; quantity decreases from Q2 to Q1. Still, the higher-price/higher-demand relationship has its limits. If the firm increases the price too much (say, from P2 to P1), making the product unaffordable for all but a few buyers, demand will begin to decrease. The direction the backward-bending curve takes shows this. Shifts in Demand The demand curves we've shown assume that all factors other than price stay the same. But what if they don't? What if the company improves the product? What happens when there is a glitzy new advertising campaign that turns a product into a "must-have" for a lot of people? What if stealthy paparazzi catch Brad Pitt using the product at home and the photo gets thousands of "likes" on Facebook? Any of these things could cause an upward shift of the demand curve. An upward shift in the demand curve means that at any given price, demand is greater than before the shift occurs. Figure 10.5 shows the upward shift of the demand curve as it moves from D1 to D2. At D1, before the shift occurs, customers will be willing to purchase the quantity Q1 (or 80 units in Figure 10.5) at the given price, P (or $60 in Figure 10.5). For example, customers at a particular store may buy 80 barbecue grills at $60 a grill. But then the store runs a huge advertising campaign featuring Rihanna on her patio using the barbecue grill. The demand curve shifts from D1 to D2. (The store keeps the price at $60.) Take a look at how the quantity demanded has changed to Q1 In our example, the store is now selling 200 barbecue grills at $60 per grill. From a marketing standpoint, this shift is the best of all worlds. Without lowering prices, the company can sell more of its product. As a result, total revenues go up, and so do profits, unless, of course, the new promotion costs as much as those potential additional profits. Demand curves may also shift downward. For example, if a rumor spreads at warp speed on Twitter that the gas grill was faulty and could cause dangerous fires, even with the price remaining at $60, the curve would shift downward, and the quantity demanded would drop so that the store could sell only 30 or 40 grills. Estimate Demand It's extremely important for marketers to understand and accurately estimate demand. Plans for production of the product as well as marketing activities and budgets must all be based on reasonably accurate estimates of potential sales. So how do marketers reasonably estimate potential sales? Marketers predict total demand first by identifying the number of buyers or potential buyers for their product and then multiplying that estimate times the average amount each member of the target market is likely to purchase. Table 10.1 shows how a small business, such as a start-up pizza restaurant, estimates demand in markets it expects to reach. For example, the pizza entrepreneur may use U.S. Census data to determine that there are 180,000 consumer households in his geographic market who normally buy pizza from various retail pizza outlets in the area. While some households buy a pizza or more every week and some never buy pizza at all, we could estimate that each household would purchase an average of six pizzas a year. The total annual demand is 1,080,000 pizzas (hold the anchovies on at least one of those, please). Table 10.1Estimating Demand for Pizza Number of families in market 180,000 Average number of pizzas per family per year 6 Total annual market demand 1,080,000 Company's predicted share of the total market 3 percent Estimated annual company demand 32,400 pizzas Estimated monthly company demand 2,700 pizzas Estimated weekly company demand 675 pizzas Once the marketer estimates total demand, the next step is to predict what the company's market share is likely to be. The company's estimated demand is then its share of the whole (estimated) pie. In our pizza example, the entrepreneur may feel that he can gain 3 percent of this market, or about 2,700 pizzas per month—not bad for a new start-up business. Of course, such projections need to take into consideration other factors that might affect demand, such as new competitors entering the market, changing consumer tastes—like a sudden demand for low-carb takeout food, or the Surgeon General proclaiming that pizza is the most perfect food for a healthy diet—but we knew that already! Price Elasticity of Demand Marketers also need to know how their customers are likely to react to a price change. In particular, it is critical to understand whether a change in price will have a large or a small impact on demand. How much can a firm increase or decrease its price until it sees a marked change in sales? If the price of a pizza increases by $1, will people switch to subs and burgers? What would happen if the pizza went up $2? Or even $5? Price elasticity of demand is a measure of the sensitivity of customers to changes in price: If the price changes by 10 percent, what will be the percentage change in demand for the product? The word elasticity indicates that changes in price usually cause demand to stretch or retract like a rubber band. We calculate price elasticity of demand as follows: Price elasticity of demand=Percentage change in quantity demandedPercentage change in price Price elasticity of demand=Percentage change in quantity demandedPercentage change in price Sometimes customers are sensitive to changes in prices, and a change in price results in a substantial change in the quantity they demand. In such instances, we have a case of elastic demand. In other situations, a change in price has little or no effect on the quantity consumers are willing to buy. We describe this as inelastic demand. Let's use the formula in this example: Suppose the pizza maker finds (from experience or from marketing research) that lowering the price of his pizza 10 percent (from $10 per pizza to $9) will cause a 15 percent increase in demand. He would calculate the price elasticity of demand as 15 divided by 10. The price elasticity of demand would be 1.5. If the price elasticity of demand is greater than one, demand is elastic; that is, consumers respond to the price decrease by demanding more. Or, if the price increases, consumers will demand less. Figure 10.6 shows these calculations. Our pizza restaurant entrepreneur doesn't really care about elasticity—he only cares about his bottom line. As Figure 10.7 illustrates, when demand is elastic, changes in price and in total revenues (total sales) work in opposite directions. If the price is increased, total sales/revenues decrease. If the price is decreased, total sales/revenues inrease. With elastic demand, the demand curve shown in Figure 10.7 is more horizontal. With an elasticity of demand of 1.5, a decrease in price will increase the pizza maker's total revenue. If demand is price inelastic, can marketers keep raising prices so that revenues and profits will grow larger and larger? And what if demand is elastic? Does it mean that marketers can never raise prices? The answer to these questions is "no" (surprise!). Elasticity of demand for a product often differs for different price levels and with different percentages of change. If we calculate the difference in demand with a price increase from $8 to $10, it will be quite different from the same $2 increase from $17 to $19 and so on. Other factors can affect price elasticity and sales. Consider the availability of substitute goods or services. If a product has a close substitute, its demand will be elastic; that is, a change in price will result in a change in demand as consumers move to buy the substitute product. For example, all but the most die-hard cola fans might consider Coke and Pepsi close substitutes. If the price of Pepsi goes up, many people will buy Coke instead. Marketers of products with close substitutes are less likely to compete on price because they recognize that doing so could result in less profit as consumers switch from one brand to another. Changes in prices of other products also affect the demand for an item, a phenomenon we label cross-elasticity of demand. When products are substitutes for each other, an increase in the price of one will increase the demand for the other. For example, if the price of bananas goes up, consumers may instead buy more strawberries, blueberries, or apples. However, when products are complements—that is, when one product is essential to the use of a second—an increase in the price of one decreases the demand for the second. So if the price of gasoline goes up, consumers may drive less, carpool, or take public transportation, and thus demand for tires (as well as gasoline) will decrease.8

10.3 identify strategies and tactics to price the product

10.3 Understand key pricing strategies and tactics. An old Russian proverb says, "There are two kinds of fools in any market. One doesn't charge enough. The other charges too much."13 In modern business, there seldom is any one-and-only, now-and-forever, best pricing strategy. Like playing a game of chess, making pricing moves and countermoves requires thinking two and three moves ahead. Figure 10.11 provides a summary of different pricing strategies and tactics. Price planning is influenced by psychological issues and strategies and by legal and ethical issues. Step 5: Choose a Pricing Strategy The next step in price planning is to choose a pricing strategy. Some strategies work for certain products, with certain customer groups, in certain competitive markets, whereas others do not. When is it best for the firm to undercut the competition and when to just meet the competition's prices? When is the best pricing strategy one that considers costs only, and when is it best to use one based on demand? Pricing Strategies Based on Cost Marketing planners often choose cost-based strategies because they are simple to calculate and are relatively risk free. They promise that the price will at least cover the costs the company incurs to produce and market the product. Cost-based pricing methods have drawbacks, however. They do not consider factors such as the changing prices of inputs, the nature of the target market, demand, competition, the product life cycle, and the product's image. Moreover, although the calculations for setting the price may be simple and straightforward, estimating costs accurately may prove difficult. Think about firms such as 3M, General Electric, and Nabisco, all of which produce many different products. How does a cost analysis allocate the costs for the plant, research and development, equipment, design engineers, maintenance, and marketing personnel among the different products so that the pricing plan accurately reflects the cost to produce any one product? For example, how do you allocate the salary of a marketing executive who oversees many different products? Should the cost be divided equally among all products? Should costs be based on the actual number of hours spent working on each product? Or should costs be assigned based on the revenues generated by each product? There is no one right answer. Even with these limitations, though, cost-based pricing strategies often are a marketer's best choice. The most common cost-based approach to pricing a product is cost-plus pricing, in which the marketer totals all the costs for the product and then adds an amount (or marks up the cost of the item) to arrive at the selling price. Many marketers, especially retailers and wholesalers who often must set the price for tens of thousands of products, use cost-plus pricing because of its simplicity; users need only know or estimate the unit cost and add the markup. You may wonder how a retailer or a wholesaler determines the markup percentage. In many cases, the markup percentage is a matter of tradition or rules of thumb. Many retailers mark up clothing, gifts, and other items by keystone pricing, or keystoning, a pricing strategy in which the retailer simply doubles the cost of the item (100 percent markup) to determine the price.14 Restaurants typically triple the costs (200 percent markup) of the food that goes into a menu item and quadruple (300 percent markup) the cost of alcoholic beverages.15 To calculate cost-plus pricing, marketers usually calculate either a markup on cost or a markup on selling price. With both methods, you calculate the price by adding a predetermined percentage to the cost, but as the names of the methods imply, for one the calculation uses a percentage of the costs, and for the other, a percentage of the selling price. Which of the two methods is used seems often to be little more than a matter of the "the way our company has always done it." You'll find more information about cost-plus pricing and how to calculate markup on cost and markup on selling price in the Chapter 10 Supplement at the end of this chapter. Pricing Strategies Based on Demand Demand-based pricing means that the firm bases the selling price on an estimate of volume or quantity that it can sell in different markets at different prices. To use any of the pricing strategies based on demand, firms must determine how much product they can sell in each market and at what price. In some cases, organizations such as local governments can actually regulate behavior by manipulating the prices people pay for services. For example, several major cities including London and Shanghai use a congestion pricing strategy to reduce their horrendous traffic jams. They have succeeded by creating "congestion zones" where drivers must pay a high fee for the privilege of operating their cars during peak times.16 You may have encountered express lanes on local highways that charge a higher toll to access less-crowded roads—you get what you pay for. As we noted previously, marketers often use customer surveys, in which consumers indicate whether they would buy a certain product and how much of it they would buy at various prices. They may obtain more accurate estimates by conducting an experiment like the ones we described in Chapter 4. Two specific demand-based pricing strategies are target costing and yield management pricing. Let's take a quick look at each approach. Today, firms find that a new product can be more successful if they match price with demand using a target costing process.17 With target costing, firms first use marketing research to identify the quality and functionality needed to satisfy attractive market segments and what price they are willing to pay before they design the product. As Figure 10.12 shows, the next step is to determine what margins retailers and dealers require as well as the profit margin the producer firm requires. On the basis of this information, managers can calculate the target cost—the maximum it can cost the firm to manufacture the product. If the firm can meet customer quality and functionality requirements and control costs to meet the required price, it will manufacture the product. If not, it abandons the product. Yield management pricing is another type of demand-based pricing strategy that hospitality businesses, like airlines, hotels, and cruise lines, use. These businesses charge different prices to different customers to manage capacity while they maximize revenues. Many service firms practice yield management pricing because they recognize that different customers have different sensitivities to price; some customers will pay top dollar for an airline ticket, whereas others will travel only if there is a discount fare. The goal of yield management pricing is to accurately predict the proportion of customers who fall into each category and allocate the percentages of the airline's or hotel's capacity accordingly so that no product goes unsold. An airline, for example, may charge two prices for the same seat—say, a full fare of $899 and a discount fare of $299. (In reality, of course, the airlines charge a much greater number of different fares.) The airline uses information about past flights to predict how many seats it can fill at full fare and how many it can sell only at the discounted fare. The airline begins months ahead of the date of the flight with a basic allocation of seats—perhaps it will place 25 percent of the seats in the full-fare "bucket" and 75 percent in the discount-fare "bucket." As flight time gets closer, the airline might make a series of adjustments to the allocation of seats in the hope of selling every seat on the plane at the highest price possible. If the New York Mets need to book the flight, chances are the airline will be able to sell some of the discount seats at full fare, which in turn decreases the number available at the discounted price. If, as the flight date nears, the number of full-fare ticket sales falls below the forecast, the airline will move some of those seats over to the discount bucket. Then the suspense builds! The pricing game continues until the day of the flight as the airline attempts to fill every seat by the time the plane takes off. This is why you may find one price for a ticket on Travelocity.com or Expedia.com a month before the flight, a much higher price two weeks later, and a very low price the last few days before the flight. This also tells you why you often see the ticket agents at the gate frantically looking for "volunteers" who are willing to give up their seats because the airline sold more seats than actually fit in the plane. Pricing Strategies Based on the Competition Sometimes a firm's pricing strategy involves pricing its wares near, at, above, or below the competition's prices. In the "good old days," when U.S. automakers had the American market to themselves, pricing decisions were straightforward: Industry giant General Motors would announce its new car prices, and Ford, Chrysler, Packard, Studebaker, Hudson, and the others got in line or dropped out. A price leadership strategy, which usually is the rule in an oligopolistic industry that a few firms dominate, may be in the best interest of all players because it minimizes price competition. Price leadership strategies are popular because they provide an acceptable and legal way for firms to agree on prices without ever coordinating these rates with each other.

10.4 pricing and electronic commerce

10.4 Understand the opportunities for Internet pricing strategies. As we have seen, price planning is a complex process in any firm. But if you are operating in the "wired world," get ready for even more pricing options! Because sellers are connected to buyers around the globe as never before through the Internet, corporate networks, and wireless setups, marketers can offer deals they tailor to a single person at a single moment. On the other hand, they're also a lot more vulnerable to smart consumers, who can easily check out competing prices with the click of a mouse. Many experts suggest that technology is creating a consumer revolution that might change pricing forever—and perhaps create the most efficient market ever. The music industry provides the most obvious example: Music lovers from around the globe purchase and download tens of billions of songs from numerous Internet sites and apps, including iTunes, Google Play, Amazon Music, and Bandcamp.24 Sixty-eight percent of smartphone users who live in the U.S. stream music on their device every day.25 And as you know, some of those people pay little to nothing for their tunes. The Internet also enables firms that sell to other businesses (B2B firms) to change their prices rapidly as they adapt to changing costs. For consumers who have lots of stuff in their attics that they need to put in someone else's attic, the Internet means an opportunity for sellers to find ready buyers through consumer-to-consumer (C2C) sites such as eBay and Etsy. And for B2C firms that sell to consumers, the Internet offers other opportunities. In this section, we'll discuss some of the more popular Internet pricing strategies. Dynamic Pricing Strategies One of the most important opportunities the Internet offers is dynamic pricing, in which the seller can quickly and easily adjust prices to meet changes in the marketplace. If a bricks-and-mortar retail store wants to change prices, employees/workers must place new price tags on items, create and display new store signage and media advertising, and input new prices into the store's computer system. For B2B marketers, employees/workers must print catalogs and price lists and distribute to salespeople and customers. These activities can be very costly to a firm, so they simply don't change their prices often.26

10.5 psychological, legal, and ethical aspects of pricing

10.5 Describe the psychological, legal, and ethical aspects of pricing. So far, we've discussed how marketers use demand, costs, and an understanding of the pricing environment to plan effective pricing strategies and tactics. There are, however, other aspects of pricing that marketers must understand and deal with to maximize the effectiveness of their pricing plans. In this section, we discuss a number of psychological, legal, and ethical factors related to pricing that are important for marketers. Figure 10.13 provides a quick look at these aspects of pricing. Psychological Issues in Setting Prices Much of what we've said about pricing depends on economists' notion of a customer who evaluates price in a logical, rational manner. For example, we express the concept of demand by a smooth curve, which assumes that if a firm lowers a product's price from $10 to $9.50 and then from $9.50 to $9 and so on, then customers will simply buy more and more. In the real world, though, it doesn't always work that way; consumers aren't nearly as rational as that! Let's look at some psychological factors that keep economists up at night. Buyers' Pricing Expectations Often consumers base their perceptions of price on what they perceive to be the customary or fair price. For example, for many years a candy bar or a pack of gum was priced at five cents (yes, five). Consumers would have perceived any other price as too high or low. It was a nickel candy bar—period. So when inflation kicked in and costs went up, some candy-makers tried to shrink the size of the bar instead of changing the price. Eventually, inflation prevailed, consumers' salaries rose, and that candy bar goes for as much as 30 times one nickel today—a price that consumers would have found unacceptable a few decades ago. When the price of a product is above or even sometimes when it's below what consumers expect, they are less willing to purchase the product. If the price is above their expectations, they may think it is a rip-off. If it is below expectations, consumers may think quality is below par. By understanding the pricing expectations of their customers, marketers are better able to develop viable pricing strategies. These expectations can differ across cultures and countries. For example, in one study researchers in southern California found that Chinese supermarkets charge significantly lower prices (only half as much for meat and seafood) than mainstream American supermarkets in the same areas.31 Internal Reference Prices Sometimes consumers' perceptions of the price of a product depend on their internal reference price. That is, based on past experience, consumers have a set price or a price range in mind that they refer to when they evaluate a product's cost. The reference price may be the last price paid, or it may be the average of all the prices they know of for similar products. No matter what the brand, the normal price for a loaf of sandwich bread is about $2.00. In some stores it may be $1.89, and in others it is $2.89, but the average is $2.00. If consumers find a comparable loaf of bread priced much higher than this—say, $3.99—they will feel it is overpriced and grab a competing brand. If they find bread priced significantly lower—say, at $0.89 or $0.99 a loaf—they may shy away from the purchase as they wonder "what's wrong" with the bread (no, we don't think that's why they call it Wonder Bread). In some cases, marketers try to influence consumers' expectations of what a product should cost when they use reference pricing strategies. For example, manufacturers may compare their price to competitors' prices when they advertise. Similarly, a retailer may display a product next to a higher-priced version of the same or a different brand. The consumer must choose between the two products with different prices. Two results are likely: On the one hand, if the prices (and other characteristics) of the two products are fairly close, the consumer will probably feel the product quality is similar. This is an assimilation effect. The customer might think, "The price is about the same, they must be alike. I'll be smart and save a few dollars." And so the customer chooses the lower-priced item because the low price makes it look attractive next to the higher-priced alternative. This is why store brands of deodorant, vitamins, pain relievers, and shampoo sit beside national brands, often accompanied by a shelf talker pointing out how much shoppers can save if they purchase the store brands. On the other hand, if the prices of the two products are too far apart, a contrast effect in which the customer equates the gap with a big difference in quality may result. The consumer may think, "Gee, this lower-priced one is probably not as good as the higher-priced one. I'll splurge on the more expensive one." Using this strategy, an appliance store may place an advertised $300 refrigerator next to a $699 model to convince a customer that the bottom-of-the-line model just won't do. Price-Quality Inferences Imagine that you go to a shoe store to check out running shoes. You notice one pair that costs $89.99. On another table, you see a second pair that looks almost identical to the first pair—but its price is only $24.95. Which pair do you want? Which pair do you think is the better quality? Many of us will pay the higher price because we believe the bargain-basement shoes aren't worth the risk at any price. Consumers make price-quality inferences about a product when they use price as a cue or an indicator of quality. (An inference means we believe something to be true without any direct evidence.) If consumers are unable to judge the quality of a product through examination or prior experience, they usually assume that the higher-priced product is the higher-quality product. In fact, new research on how the brain works even suggests that the price we pay can subtly influence how much pleasure we get from the product. Brain scans show that—contrary to conventional wisdom—consumers who buy something at a discount experience less satisfaction than people who pay full price for the very same thing. For example, in one recent study, volunteers who drank wine that they were told cost $90 a bottle actually registered more brain activity in pleasure centers than did those who drank the very same wine but who were told it only cost $10 a bottle. Researchers call this the price-placebo effect. This is similar to the placebo effect in medicine where people who think they are getting the real thing but who are actually taking sugar pills still experience the effects of the real drug.32

captive pricing

A pricing tactic for two items that must be used together; one item is priced very low, and the firm makes its profit on another, high-margin item essential to the operation of the first item.

airbnb

A sharing service for consumers to lease or rent short-term lodging, including holiday cottages, apartments, homestays, hostel beds, and hotel rooms.

internet price discrimination

Of course, the Internet allows firms to do more than just adjust prices as a result of external factors such as changing costs or competitive activity. The promise of the Internet is that it allows consumers to quickly comparison shop for the lowest price, all the while sitting in their pajamas at home. Many firms, it seems, use the same technology to practice Internet price discrimination. Internet price discrimination is an Internet pricing strategy that charges different prices to different buyers for the same product based on order size or geographic location.27 A Wall Street Journal investigation found that a Swingline stapler on Staples.com was priced at $15.79 for one customer and $14.29 for another who lived just a few miles away based on their location and their distance from either an OfficeMax or an Office Depot store.28 Marketers know that they will maximize profits if they charge each customer the most that person is willing to pay. Although this is not practical, placing customers into groups based on where they live, how close they are to the retailer or a competitor, the cost of doing business in the area, or their Internet browsing history can greatly increase profits. Some sites even offer customers a discount if they use a mobile device. A shopper who uses a smartphone to find a hotel room on sites like Orbitz.com or CheapTickets.com may find rooms for as much as 50 percent less than they would otherwise pay. Is Internet price discrimination illegal? As we said in our discussion of price segmentation, as long as companies don't charge different prices based on a demographic characteristic such as gender or race, it is not. Sometimes, however, it's difficult to tell how the company makes these decisions. For example, a recent report found that The Princeton Review, which charges different prices for its SAT prep service to consumers who live in different zip codes, is almost twice as likely to offer a higher price to Asians who ask for an online quote compared to non-Asians. This doesn't necessarily mean the company is intentionally discriminating against Asians, but rather that these consumers are more likely to live in zip codes assigned to the higher rates. As the company responded, "The areas that experience higher prices will also have a disproportionately higher population of members of the financial services industry, people who tend to vote Democratic, journalists, and any other group that is more heavily concentrated in areas like New York City."29

freemium price strategies

Perhaps the most exciting new pricing strategy is freemium pricing (a mix of "free" and "premium"). Freemium is a business strategy in which a company provides its most basic version free of charge but then charges (the premium) for upgraded versions of the product with more features, greater functionality, or greater capacity.30 The freemium pricing strategy has been most popular in digital offerings such as software media, games, or web services where the cost of one additional copy of the product is negligible. Companies that have followed the new pricing strategy include Dropbox, Inc., SurveyMonkey, Spotify, and Skype. The idea is that if you give your product away, you will build a customer base of consumers willing to pay for the added benefits. Whereas some products, such as Skype, have been highly successful, others have found that customers never upgrade to the premium version of the product. Pandora, the music streaming service, realized that many consumers were unwilling to pay for its service, so it changed its business model to include a free service supported by paid advertising plus its Pandora One paid service without the ads.

predatory pricing

Predatory pricing means that a company sets a very low price for the purpose of driving competitors out of business. Later, when they have a monopoly, they turn around and increase prices. The Sherman Act and the Robinson-Patman Act prohibit predatory pricing. For example, online retailer Amazon was accused of predatory pricing centered on its book sales in 2014. Due to its sheer size, Amazon is able to sell books at a discounted rate to customers looking for a deal. The concern is that, over time, this discount option will capture the vast majority of the market share, making it virtually impossible for other retailers to succeed. The claim was that Amazon's aggressive pricing model could trickle down to authors and push the amount they were paid for their work down to nearly nothing.40

price-fixing

Price-fixing occurs when two or more companies conspire to keep prices at a certain level. Horizontal price-fixing occurs when competitors making the same product jointly determine what price they each will charge. Of course, parallel pricing among firms in industries in which there are few sellers is not in and of itself considered price-fixing. There must be an exchange of pricing information between sellers to indicate illegal price-fixing actions. The Sherman Antitrust Act of 1890 specifically makes this practice, referred to as collusion, illegal. In 2017, the Canadian Competition Bureau found grocery giant Loblaw guilty of participating in a scheme to increase the prices of packaged bread products in a 16-year-long conspiracy. Loblaw's parent company, George Weston, came forward to report the collusion on the promise of immunity from prosecution. According to George Weston, officials from their company and officials at Canada Bread Company communicated directly at least 15 times about raising the price of baked goods to the end consumer. Loblaw claims that other grocery chains were involved, including Walmart, Sobeys, and Giant Tiger.39 Vertical price fixing occurs when manufacturers or wholesalers attempt to force retailers to charge a certain price for their product. When vertical price-fixing occurs, the retailer that wants to carry the product must charge the "suggested" retail price. The Consumer Goods Pricing Act of 1976 limited this practice, leaving retail stores free to set whatever price they choose without interference by the manufacturer or wholesaler. Today, retailers don't need to adhere to "suggested" prices.