Chapter 10 MKT 300

Put-away

refers to moving goods to their temporary or semipermanent storage location and updating inventory records.

Even pricing

sets prices at even dollar amounts. Prices that end with zero are often easier for customers to process and retrieve from memory. In addition, luxury product marketers often use even pricing; odd pricing, often ending in 9, can sometimes convey a message of discount or sale that is not consistent with a luxury pricing objective. Research has even suggested that prices ending in 00 increased the likelihood of consumers rating the quality of the items advertised as "above average.

Break-Even Analysis

Once a company estimates fixed and variable costs, it can incorporate them into a break-even analysis. Break-even analysis is the process of calculating the break-even point, which equals the sales volume needed to achieve a profit of zero. Specifically, the break-even point is the point at which the costs of producing a product equal the revenue made from selling the product. Once the firm has established the break-even point, it can determine how much it would need to sell to earn a profit on the product. To calculate the break-even point, we divide total fixed costs by the unit contribution margin. The unit contribution margin is the amount of revenue a product contributes per unit; it is calculated as the selling price per unit minus the variable costs per unit Total fixed costs/unit contribution margin = total fixed costs/(selling price per unit - variable cost per unit) = break even point in units

Mobile Applications

Smartphone and tablet technology has unleashed a new era of pricing transparency. Consumers now use wireless apps and search engines on their mobile devices in stores to compare prices. In response, marketers at traditional brick-and-mortar stores more aggressively review the prices of online stores when setting the initial price of an item as part of their analysis of the competitive price environment. With more people using their mobile devices to order products, apps are becoming increasingly important in directing users to online purchasing sites. Popular price-comparison apps like eBay Inc.'s RedLaser have been downloaded more than 15 million times and provide consumers the chance to compare prices throughout much of the world. RedLaser and other popular apps like Shop Savvy allow users to scan barcodes, take a photo, or search a product while in a store. The app then displays how much online competitors charge for that product and allows customers to immediately purchase the product through their mobile device. Recent research suggests that over 40 percent of consumers search for and purchase a low-priced product using an in-store shopping app or online search engine.

Step 5: Choose a Price

So far, we've seen that determining the costs provides a lower price limit, and analyzing the competition narrows the range of prices that can be charged. After completing these two steps, it is time for marketers to choose a price. Again, the pricing decision should be made with the goal of maximizing long-term, sustainable profits. Because choosing a price is a complicated process, firms rarely do it perfectly. The next major section of the chapter discusses the most common tactics for determining price. Before we get there, we'll discuss two often-overlooked factors that influence price: reference prices and underpricing.

TECHNOLOGY AND PRICING

Technology influences pricing strategy in a significant and growing way. Technology has helped to shift the balance of power from companies to customers, who are better informed about prices than ever before. The Internet has made it possible for customers to comparison shop for products literally around the world. If you had taken this course a generation ago, your pricing options for buying this product would have been whatever the campus bookstore charged. Today, you can comparison shop at bookstores throughout the U.S. and online marketplaces such as Amazon or buy digital copies directly from the publisher. In addition to the power of the Internet, mobile applications and dynamic pricing are rapidly changing the nature of pricing.

Step 1: Define the Pricing Objectives

The first step in setting a price is to clearly define the pricing objectives. Pricing objectives should be an extension of the firm's marketing objectives. They should describe what a firm hopes to achieve through pricing. Similar to the firm's marketing objectives, pricing objectives should be specific, measurable, and reflect the market realities the firm faces. Common pricing objectives include profit maximization, volume maximization, and survival.

Name-Your-Own-Price

The power of technology is allowing companies to experiment with the name-your-own-price auction, a pricing tactic popularized by firms like Priceline.com. In a name-your-own-price (NYOP) auction, the consumer submits a bid at the price he or she is willing to pay for a product or service, and the auction site conducts a search to find matches with prices set by participating suppliers. Specifically, the auction site looks to see whether the bid price matches or exceeds any unrevealed threshold prices set by participating suppliers. If it does find a match, the bid is accepted. The auction site retains as its revenue any difference between the bid price and the supplier's threshold price. If no match is found, the bid is rejected. Use of NYOP auctions is common among companies that consolidate and offer hotel and airline tickets.

Price Discrimination

You may be surprised to hear that you have likely benefited from discriminatory pricing in various ways. If you've paid student prices at a movie theater, or have been given an introductory price to switch cell phone or cable providers, you've taken advantage of price discrimination. Price discrimination is the practice of charging different customers different prices for the same product. Price discrimination sounds negative, but it is illegal only if it injures competition. It is perfectly legal for organizations to charge customers different amounts for legitimate reasons. This is especially common in B2B settings, in which different customers might be charged different rates due to the quantities they buy, the strategic value of the company, or simply because one firm did a better job negotiating the contract. Later in this section, we'll discuss the Robinson-Patman Act, which has helped to clarify when price discrimination can and cannot be used.

Escalator clause

in an agreement provides for price increases if certain, specified conditions occur. The escalator clause ensures that providers of goods and services do not encounter unreasonable financial hardship as a result of uncontrollable factors relating to the product. Those factors could involve either increases in the costs of materials or decreases in the availability of something required to deliver products to customers. For example, an escalator clause in a logistics contract can take the form of a fuel surcharge that allows trucking companies to adjust prices based on the current price of fuel.

Picking

involves retrieving packaging and raw materials from storage and moving them to manufacturing to fulfill needs for those materials in production. For finished goods, picking involves retrieving items from storage and preparing them for shipment to fulfill a customer order.

gray market

involves the sale of branded products through legal but unauthorized distribution channels. This form of buying and selling often occurs when the price of an item is significantly higher in one country than another. Individuals or groups buy new or used products for a lower price in a foreign country and import them legally back into the domestic market, where they sell them for less than the normal market price.

Price elasticity of demand

is a measure of price sensitivity that gives the percentage change in quantity demanded in response to a percentage change in price (holding constant all the other determinants of demand, such as income). It is one of the most important concepts in marketing and should be considered when pricing any product.

Dumping

occurs when a company sells its exports to another country at a lower price than it sells the same product in its domestic market.

The other three elements of the marketing mix

—product, promotion, and place —come together to determine how marketers capture value through pricing. Price is the amount of something —money, time, or effort —that a buyer exchanges with a seller to obtain a product.

Step 3: Determine the Costs

A marketer should understand all of the costs associated with its product offering, whether the product is a good, service, idea, or some combination of these. Accurately determining the costs sets a lower price limit for marketers. It also ensures that the company will not lose money by pricing its products too low. Although a firm may temporarily sell products below cost to generate sales as part of a survival-pricing strategy, it cannot endure for very long employing this strategy. Setting a price begins by knowing the fixed and variable costs that go into producing a good or service.

Purchase order

Based on the terms of the negotiations, the purchasing manager writes a purchase order, which is a legal obligation to buy from a supplier a certain amount of product, at a certain price, to be delivered at a specified date.

Step 6: Monitor and Evaluate the Effectiveness of the Price

Choosing a price is not a one-time decision. Pricing strategy evolves throughout the product life cycle; it needs repeated monitoring and evaluation, to determine how effectively the strategy meets the pricing objectives. For example: Marketers in the introduction stage for a new type of smartphone might select a price-skimming strategy; its goal would be to achieve maximum profits from innovators and early adopters. As the product enters the growth stage, it customer base expands. The firm might gradually lower prices as it achieves economies of scale and more competitors enter the market. Once the product enters the decline stage of the product life cycle, the firm might decide to use survival pricing to clear out remaining inventories and sustain the product for as long as possible. One of the most challenging aspects of pricing is initiating price increases. It is hard to imagine a customer being excited about paying more for the same product. However, in an effort to recover increasing costs or improve profits, firms often face situations that require price increases. For example, restaurants Wendy's and Arby's were both forced to raise prices after the cost of beef and other key ingredients increased by more than 5 percent. Two of the most common and effective strategies for raising prices are unbundling and escalator clauses.

Fixed v. Variable costs

Costs that remain constant and do not vary based on the number of units produced or sold are called fixed costs. Examples of fixed costs include salaries, rent, insurance, and advertising costs. Since these costs will be incurred regardless of the level of production or sales activity, they must be recovered during the course of doing business. Marketers must set a final price that allows the firm to cover fixed costs over the long term. Costs that vary depending on the number of units produced or sold are called variable costs. Variable costs include things such as raw material, sales commissions, and delivery costs. To illustrate the difference between the two types of costs, let's use our car dealership example again: Fixed costs for a car dealership include rent for the offices and showroom and employee salaries and benefits. These costs exist each month. They do not change even if, for example, an additional 10 cars are sold in one month. Variable costs for a car dealership would include things like commissions for the dealership's salespeople.

Dynamic pricing

Dynamic pricing is a pricing tactic that involves constantly updating prices to reflect changes in supply, demand, or market conditions. While dynamic pricing is not new, its popularity has grown explosively due to improving and readily available technological tools that facilitate its use. Digital sales environments can provide marketers with an abundance of sales data. These data may contain important insights on consumer behavior, in particular, on how consumers respond to different selling prices. Marketers can apply these insights to their own dynamic pricing policies. Dynamic pricing helps marketers emphasize yield management, which is a strategy for maximizing revenue even when a firm has a fixed amount of something (goods, services, or capacity). A sports teams, for example, has only a finite number of seats in its stadium. A team might want to charge the maximum possible price for a ticket, but if the price is too high, actual attendance at the game might suffer. In contrast, if prices are set too low, the team's marketers have missed an opportunity to improve their revenue

Pricing is one of the most important strategic decisions a firm faces: Price, revenue, profit

It reflects the value the product delivers to consumers as well as the value the product captures for the firm. When used correctly, pricing strategies can maximize profits and help the firm take a commanding market position. When used incorrectly, pricing strategies can limit revenue, profits, and brand perceptions. Pricing is the essential element for capturing revenue and profits. Revenue is the result of the price charged to customers multiplied by the number of units sold. Profits are the firm's "bottom line": revenue minus total costs. These two calculations, represented in the following equations, underlie the firm's entire marketing strategy: Revenue = Units sold X price Profit = revenue - cost The objective of strategic pricing is profitability. The majority of marketers and firms throughout the world seek to increase revenue, which can ultimately lead to increased profits. There are only two ways to increase revenue: sell more products or sell them at a higher price. As a result of this reality, in order to maximize profits, marketers must make strategic trade-offs between volume and price.

Price-setting process

Many factors influence how a firm sets prices. A firm's various stakeholders may voice a preference for higher or lower prices, depending on their point of view: Marketing executives in search of substantial profits typically want high prices across the products they sell. Salespeople often want lower prices, to increase the perceived customer value and ultimately the number of units sold. Customers, too, want low prices, to maximize their purchasing power. Thoughtful consideration of the impact on all stakeholders at each step in the price-setting process, illustrated in Figure 10.1, increases the likelihood that the final price captures value for the firm and delivers value to the customer.

Price sensitivity

Marketers need to project not only the overall market demand but also the specific product demand at various price points. This requires an understanding of consumers' price sensitivity, which is the degree to which the price of a product affects consumers' purchasing behavior. A consumer shopping for a new car who cannot afford to spend more than a certain amount on such a large purchase will be more price-sensitive than a consumer with more money to spend on a car or a consumer shopping for a smaller purchase like a new piece of clothing. So, the size of the expenditure affects price sensitivity. Consumers are also more price-sensitive if the price they see for a new car at the dealership is outside the range of what the consumer believes is fair. Regardless of the car's features, a consumer is less likely to pay the price if it's more than he or she considers reasonable. Consumers often become more price-sensitive as they become aware of potential substitute products. If a consumer can review and compare the prices and performance of available cars throughout the region, the perceived risk for the buyer declines, and the consumer becomes more price-sensitive.

Markup Pricing

Markup pricing (also known as cost-plus pricing) is one of the most commonly used pricing tactics, largely because it is easy. In markup pricing, marketers add a certain amount, usually a percentage, to the cost of the product, to set the final price. Markup price = unit cost of product + (desired % return x unit cost) Though markup pricing has the advantage of being easy, it's not very effective at maximizing profits, which is the ultimate objective of a good pricing strategy

PRICING TACTICS

Once marketers have completed their analysis of demand, costs, and the competitive environment, they can use a number of different tactics to choose a final price. In this section, we will discuss several of the most common methods and discuss the advantages and disadvantages of each. Pricing tactics are short- or long-term attempts to adjust the pricing of a product to achieve a particular pricing objective. Which tactic to use depends on the value customers perceive the product to have, their ability to pay, and how they intend to use the product.

Predatory pricing

Predatory pricing is the practice of first setting prices low with the intention of pushing competitors out of the market or keeping new competitors from entering the market, and then raising prices to normal levels

Seasonal Discounts

Price reductions given to customers purchasing goods or services out of season are called seasonal discounts. Disney World pursues this strategy by offering its best rates when demand is at its lowest due to cold weather (e.g., January and February) and the fact that children are in school. Seasonal discounts enable Disney World to maintain a steady stream of visitors to its parks year-round. The strategy also exposes new customers to the brand. Young families (those with children younger than school age) can try Disney World during its value season; many go on to become loyal customers, purchasing Disney vacations during the peak summer seasons once their children start school. Marketers for a variety of firms and industries, such as ski lodges in the summer and cruises during non-peak times, utilize seasonal discounts to keep attendance high throughout the year.

Pricing

Pricing affects your life each day; it is part of almost every consumer decision that you make. Whether you are buying a new car or ordering lunch, the prices of the products you are considering typically factor into your decision about what to purchase. If the price for a lunch special is too high, you may buy something else to eat. But consider that, if the restaurant charges less than you would have been willing to pay, it has reduced its revenue.

Step 4: Analyze the Competitive Price Environment

Pricing does not occur in a vacuum. Marketers must consider what competitors charge for their products. Setting prices to compete against other firms is challenging and complex, with various possible strategies: Match competitor prices. Price lower than competitors, thus offering customers greater value. Price higher because the firm offers a superior product. This decision should be consistent with the overall marketing objectives of the firm and the other three marketing-mix elements.

Profit Maximization

Profit maximization is designed to maximize profits on each unit sold. Profit maximization involves setting a relatively high price for a period of time after the product launches. Profit maximization assumes that customers value a product's differentiating attributes; as a result, they are willing to pay a higher price to take advantage of those attributes, especially early in a product's life cycle. Apple's pricing of a newly released iPad model provides a good example of profit maximization.

Step 2: Evaluate Demand

The second step in setting a price is evaluating demand for the product at various price levels. The concept of supply and demand sits at the heart of setting prices. According to traditional economic theory, setting prices is as simple as finding the point at which the quantity demanded of a good or service at a particular price equals the quantity supplied by producers at that price. Determining the quantity that producers are willing and able to supply involves looking at costs. No company can afford, for very long, to sell its goods or services at prices that do not cover costs. For producers, the optimal price is the point at which marginal revenue equals marginal cost. Marginal revenue is the change in total revenue that results from selling one additional unit of product. Marginal cost is the change in total cost that results from producing one additional unit of product.

Price Bundling

There are usually two ways to purchase products: à la carte (individually) or as a bundle. Price bundling is a pricing tactic in which two or more products are packaged together and sold at a single price. Marketers often use bundling as a tool because they can charge higher prices for the bundle than they could for the elements individually.

Various laws

To combat price discrimination that injures competition, in 1936 the United States government passed the Robinson-Patman Act as an amendment to the Clayton Antitrust Act of 1914. The Robinson-Patman Act (also called the Anti-Price Discrimination Act) requires sellers to charge everyone the same price.25 It grew out of concerns that large companies would leverage their buying power to purchase goods at lower prices than smaller companies could. Though the purpose of the act was to reduce injurious price discrimination, it did provide for three scenarios in which price discrimination may be allowed: A firm can charge different prices if it is part of a quantity or manufacturing discount program. For example, a company selling 5,000 laptops to a multibillion-dollar company can charge less per unit than if it sells the same laptop to an individual consumer buying just one. A firm can lower prices for certain customers if a competitor undercuts the originally quoted price. This rule affects Walmart and several large retailers that promise to match any competitor's price if the consumer produces proof of the lower price. These retailers are not legally required to extend this same Page 337discount to customers who do not present proof of the lower price, effectively resulting in different prices for different customers. Finally, market conditions such as going-out-of-business sales or situations in which the quality of products has changed give firms the opportunity to charge different prices for the same product. For example, a bakery may sell loaves of French bread for $3 each on the day it bakes them. However, it would be allowed to sell the same loaves the next day at a steep discount since the quality and freshness of the bread has deteriorated. Federal Trade Commission Act The Federal Trade Commission Act (FTCA) was passed in 1914. It established the Federal Trade Commission (FTC), which had the authority to enforce laws aimed at prohibiting unfair methods of competition.26 The FTCA was later broadened to prevent practices such as price fixing and deceptive pricing that: may cause injury to customers. cannot be reasonably avoided by customers. cannot be justified by other outcomes that may benefit the consumer or the idea of free competition. Wheeler-Lea Act The Wheeler-Lea Act of 1938 (also called the Advertising Act) is an amendment to the FTCA.27 Its passage removed the burden of proving that unfair and deceptive practices had to injure competition as well as customers. It also broadened the FTC's powers to include protecting consumers from false advertising practices. Sherman Antitrust Act As described in an earlier chapter (but worth repeating here), the Sherman Antitrust Act was passed in 1890 to eliminate monopolies and guarantee competition. It combats anticompetitive practices, reduces market domination by individual corporations, and preserves unfettered competition as the rule of trade. As described above, the Sherman Antitrust Act makes price fixing illegal.

Price fixing

When two or more companies collude to set a product's price, they are engaging in price fixing. Price fixing is illegal under the Sherman Antitrust Act of 1890 and the Federal Trade Commission Act (both of which we discuss later in the chapter)

Tariffs

are taxes on imports and exports between countries.

Reference prices

are the prices that consumers consider reasonable and fair for a product. Reference prices matter to marketers because consumers are typically more price-sensitive the higher a product's price is relative to expectations.

Survival pricing

involves lowering prices to the point at which revenue just covers costs, allowing the firm to endure (survive) during a difficult time. The survival objective is designed to maximize cash flow over the short term and is typically implemented by a struggling firm. It should not be a permanent pricing objective, though it can be useful as a temporary means of staying in business: During the recession that began in late 2007, General Motors (as well as a number of other companies) reduced prices in an effort to avoid bankruptcy and sustain the firm.

Loss-leader pricing

involves selling a product at a price that causes the firm a financial loss. Although the firm may lose money selling the product at that price, it might attract customers who will also buy other, more profitable products in the future. For example, department stores often drop the price of well-known products to increase overall store traffic. This worked better at a time when consumers would do most of their shopping on-site; their additional purchases at the store would make up for the loss-leader item. However, consumers today have more pricing information at their fingertips and more options for purchasing online. The result can be that firms sell only the loss-leader product and never make up the profits, as customers go elsewhere to buy the more profitable products.

Unbundling

involves separating out the individual goods, services, or ideas that make up a product and pricing each one individually. Such a strategy allows marketers to maintain a similar price on the core product but recover costs in other ways on related goods and services. For example, a restaurant might unbundle a meal so that the hamburger sells for the same price, but the customer now must pay extra for the french fries. Airlines have pursued an unbundling strategy over the course of the last decade. They now charge separate fees for baggage rather than bundling luggage fees into the cost of the ticket.

Materials management

involves the inbound movement and storage of materials in preparation for those materials to enter and flow through the manufacturing process. Effective materials management benefits the company in the following four ways:19 Reduces procurement, transportation, and production costs through economies of scale. Coordinates supply and demand for materials. Cyclical, safety, and anticipative stocks are held in warehouses until needed. Supports manufacturing activities. Materials management ensures that stored or recently received materials get to the production floor when they are needed. Supports marketing objectives by making sure that goods are available to ship to customers in an efficient and effective manner.

Prestige pricing

is a pricing tactic that involves pricing a product higher than competitors to signal that it is of higher quality. Luxury brands such as Louis Vuitton, Cartier, Rolex, and Mercedes-Benz are perfect examples of this strategy. Such companies use high prices to suggest their products are high quality and stylish. Simply improving the look, packaging, delivery, or promise of a product can justify a higher price and support prestige pricing.

Odd pricing

is a tactic in which a firm prices products a few cents below the next dollar amount. For the strategy to succeed, customers must perceive a product priced at $19.95 as offering more value than a product priced at $20.00. Though the price difference seems immaterial, if customers feel they received a deal, they are more likely to share that feeling with others, which can lead to additional sales. Firms that use odd pricing still need to consider the impact of price elasticity of demand at odd-pricing points

Deceptive pricing

is an illegal practice that involves intentionally misleading customers with price promotions. Deceptive pricing practices can lead to price confusion, with consumers finding it difficult to discern what they are actually paying. The most common examples of deceptive pricing involve firms that falsely advertise wholesale pricing or promise a significant price reduction on an artificially high retail price. Deceptive-pricing practices have come under fire in recent years in industries ranging from credit cards to home loans. In these cases, important information was often buried deep within little-noticed and hard-to-read disclaimers and information.

Inelastic demand

is demand for which a given percentage change in price results in a smaller percentage change in quantity demanded. As a marketing professional, if salespeople or others in an organization approach you asking for a price reduction to sell more units, your first question should be: "How many more units do you expect to sell at the reduced price?" If the additional sales don't offset the price reduction, you would not want to approve the request.

Elastic demand

is demand for which a given percentage change in price results in an even larger percentage change in quantity demanded. Prices are generally more elastic in the early stages of the product life cycle and increasingly inelastic in the later stages of the product life cycle.

Volume maximization

is designed to maximize volume and revenue for a firm. Volume maximization is the process of setting prices low to encourage a greater volume of purchases.

Profit margin

is the amount a product sells for above the total cost of the product itself. Notice that if the firm uses the 20 percent markup, the profit margin for each customer who purchases a lawn chair will always be $2 ($12 selling price − $10 unit cost) due to the 20 percent markup. Customer #1 would not purchase the chair because its perceived value is less than the $12 price. Customers #2, #3, and #4 would purchase the chair, giving the firm a total profit of $6 ($2 profit margin × 3). But if the firm were to use markup pricing, it would lose the difference between the amount of each customer's perceived value and the $12 price.