Chapter 19 Pricing Concepts

Tactics for Fine-Tuning the Base Price

- Discounts, allowances, and rebates - Value-based pricing - Geographic pricing - Other pricing strategies

Factors that Affect Elasticity

- availability of substitutes - price relative to purchasing power - product durability - a product's other uses

Discounts, Allowances, Rebates, and Value-Based Pricing

A base price can be lowered through the use of discounts and the related tactics of allowances, rebates, low or zero percent financing, and value-based pricing

Target Return on Investment

The most common profit objective is a target return on investment (ROI, sometimes called the firm's return on total assets. − Return on investment (ROI) = Net profit after taxes ÷ Total assets • ROI measures management's overall effectiveness in generating profits with the available assets as compared to the industry average.

Market share

a company's product sales as a percentage of total sales for that industry • Larger market shares have often meant higher profits, thanks to greater economies of scale, market power, and ability to compensate top-quality management.

Fixed cost

a cost that does not change as output is increased or decreased

Variable cost

a cost that varies with changes in the level of output

Noncumulative quantity discount

a deduction from list price that applies to a single order rather than to the total volume of orders placed during a certain period

Cumulative quantity discount

a deduction from list price that applies to the buyer's total purchases made during a specific period

Coupons

a discount offered via paper, a card, a printable web page, or an electronic code

Functional discount (trade discount)

a discount to wholesalers and retailers for performing channel functions

Break-even analysis

a method of determining what sales volume must be reached before total revenue equals total costs

Zone pricing

a modification of uniform delivered pricing that divides the United States (or the total market) into segments or zones and charges a flat freight rate to all customers in a given zone

Promotional allowance (trade allowance)

a payment to a dealer for promoting the manufacturer's products

Seasonal discount

a price reduction for buying merchandise out of season

Cash discount

a price reduction offered to a consumer, an industrial user, or a marketing intermediary in return for prompt payment of a bill

Quantity discount

a price reduction offered to buyers buying in multiple units or above a specified dollar amount

Freight absorption pricing

a price tactic in which the seller pays all or part of the actual freight charges and does not pass them on to the buyer

Uniform delivered pricing

a price tactic in which the seller pays the actual freight charges and bills every purchaser an identical, flat freight charge

Basing-point pricing

a price tactic that charges freight from a given (basing) point, regardless of the city from which the goods are shipped

FOB origin pricing

a price tactic that requires the buyer to absorb the freight costs from the shipping point ("free on board")

Status quo pricing

a pricing objective that maintains existing prices or meets the competition's prices − Status quo pricing often leads to suboptimal pricing because the strategy ignores customers' perceived value of both the firm's goods or services and those offered by its competitors.

Price skimming

a pricing policy whereby a firm charges a high introductory price, often coupled with heavy promotion − This strategy is often used for new products when the product is perceived by the target market as having unique advantages. − Price skimming works best when there is strong demand for a good or service, when a product is well protected legally, when it represents a technological breakthrough, or when it has in some other way blocked the entry of competitors.

Penetration pricing

a pricing policy whereby a firm charges a relatively low price for a product when it is first rolled out as a way to reach the mass market − If obtaining a large market share is the firm's pricing objective, penetration pricing is a logical choice. − A penetration strategy tends to be effective in a price-sensitive market. Price should decline more rapidly when demand is elastic because the market can be expanded through a lower price. − It typically discourages or blocks competition from entering a market.

Inelastic demand

a situation in which an increase or a decrease in price will not significantly affect demand for the product

Elastic demand

a situation in which consumer demand is sensitive to changes in price

Zero percent financing

a type of loan that enables purchasers to borrow money to pay for products with no interest charge

Fine-tuning techniques allow the firm to

adjust for competition in certain markets, take advantage of unique demand situations, and meet goals

Price fixing

an agreement between two or more firms on the price they will charge for a product − Such practices are illegal under the Sherman Act and the Federal Trade Commission Act.

New customer discounts

an initial discount offered to new customers with the objective of creating a long-term relationship with a new client and therefore a long-term revenue stream

Sales-oriented pricing objectives

based on market share as reported in dollar or unit sales

Elasticity of demand

consumers' responsiveness or sensitivity to changes in price

The typical break-even model assumes a

given fixed cost and a constant average variable cost (total cost divided by quantity of output)

Some pricing decisions are subject to

government regulation

Limitations (typical break-even model)

hard to know whether a cost is fixed or variable; hard to know if there is sufficient demand

Unfair trade practice acts

laws that prohibit wholesalers and retailers from selling below cost − Wholesalers and retailers must usually take a certain minimum percentage markup on their combined merchandise cost and transportation cost. − State enforcement of unfair trade practice laws has generally been lax, partly because low prices benefit local consumers.

Free shipping

lowers the price for purchasers, but the expense must be built into the cost of the product

Surge pricing

occurs in a fluid market, where demand changes rapidly, often hourly. When demand increases, so do prices, and vice versa

Price Discrimination - The Robinson-Patman Act of 1936

prohibits any firm from selling to two or more different buyers, within a reasonably short time, commodities (not services) of like grade and quality at different prices where the result would be to substantially lessen competition − The act also makes it illegal for a seller to offer two buyers different supplementary services and for buyers to use their purchasing power to force sellers into granting discriminatory prices or services

Advantage (typical break-even model)

provides a quick estimate of how much the firm must sell to break even and how much profit can be earned if a higher sales volume is obtained

Profit Maximization

setting prices so that total revenue is as large as possible relative to total costs while still remaining competitive - In attempting to maximize profits, managers can try to expand revenue by increasing customer satisfaction or reduce costs by operating more efficiently, or both

Reframing discount and markdown math

showing the sales price with final dollar amounts rather than percentage discounts, or showing the final cost after all discounts have been applied, to make price reductions easier to understand

Other Pricing Tactics

single price tactic flexible pricing/variable pricing professional services pricing price lining leader pricing (loss leader pricing) bait pricing odd-even pricing (psychological pricing) price bundling two-part pricing pay what you want package content reduction

To survive in today's highly competitive marketplace, companies must choose pricing objectives that are

specific, attainable, and measurable

Price

that which is given up in an exchange to acquire a good or service

Dynamic pricing

the ability to change prices very quickly, often in real-time using software programs - can be used in any industry in which demand or supply fluctuates

Sometimes companies minimize or ignore the importance of demand and decide to price their products largely or solely on the basis of

the company's costs

Markup Pricing

the cost of buying the product from the producer, plus amounts for profit and for expenses not otherwise accounted for

Markup pricing

the cost of buying the product from the producer, plus amounts for profit and for expenses not otherwise accounted for − To use markup based on cost or selling price effectively, the marketing manager must calculate an adequate gross margin—the amount added to cost to determine price

Gambled price discounts

the customer receives a discount based on the outcome of a probabilistic gamble (and which is therefore uncertain)

Base price

the general price level at which the company expects to sell the good or service

Predatory pricing

the practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market − Once competitors have been driven out, the firm raises its prices • This practice is illegal under the Sherman Act and the Federal TradeCommission Act. − To prove predatory pricing, the Justice Department must show that the predator—the destructive company—explicitly tried to ruin a competitor and that the predatory price was below the predator's average variable cost.

Keystoning

the practice of marking up prices by 100 percent, or doubling the cost

After managers understand both the legal and the marketing consequences of price strategies,

they should set a base price

Prices determined strictly on the basis of costs may be too high for the target market or too low, resulting in

unnecessarily low returns

When competitive pressures are high, a company must know

when it should raise or lower prices to maximize its revenues

The Sacrifice Effect of Price

• "That which is given up" usually means money • Consumers may also sacrifice time or forego other products and services

The Information Effect of Price

• Consumers do not always choose the lowest-priced product in a category. • We infer quality information from price—higher quality equals higher price. • Higher prices can also convey prestige and status.

Sales Maximization

− Rather than strive for market share, which is not always an indicator of profitability, some companies try to maximize sales.− A firm with the objective of maximizing sales ignores profits, competition, and the marketing environment as long as sales are rising. − To generate a maximum amount of cash in the short run, management may opt for the price -quantity relationship that generates the greatest cash revenue. − Maximization of cash should never be a long-run objective because cash maximization may mean little or no profitability.

Geographic Pricing

Because many sellers ship their wares to a nationwide or even a worldwide market, the cost of freight can greatly affect the total cost of a product

Value is based on perceived satisfaction

Consumers are interested in obtaining a "perceived reasonable value" for the price at the time of the purchase

Product's other uses

The more uses there are for a product, the more elastic demand tends to be

Price relative to purchasing power

If a price is so low that it is an inconsequential part of an individual's budget, demand will be inelastic

Satisfactory Profits

Rather than maximizing profits, many organizations strive for profits that are satisfactory to the stockholders and management

Other Determinants of Price

Stages of the Product Life Cycle Competition, price matching, and customer loyalty Distribution Strategy Impact of the Internet and extranets Promotion strategy Demands of large customers Relationship of price to quality

Availability of Substitutes

When many substitute products are available, the consumer can easily switch from one product to another, making demand more elastic. When there is no substitute, demand is more inelastic

Product durability

With durable products, consumers often have the option of repairing rather than replacing them, thus prolonging their useful life. This makes people more sensitive to price increases, meaning demand is more elastic

Rebate

a cash refund given for the purchase of a product during a specific period