Chapter 14 - Developing Price Strategies and Programs

SETTING THE PRICE

A firm must set a price for the first time when it develops a new product, when it introduces its regular product into a new distribution channel or geographical area, and when it enters bids on new contract work. The firm must decide where to position its product on quality and price. The six steps in the process of setting pricing policy: Step 1: Selecting the Pricing Objective Step 2: Determining Demand Step 3: Estimating Costs Step 4: Analysing Competitors' Costs, Prices, and Offers Step 5: Selecting a Pricing Method Step 6: Selecting the Final Price

Promotional Pricing

Companies can use several pricing techniques to stimulate early purchase: - Loss-Leader Pricing - Special Event Pricing - Special Customer Pricing - Cash Rebates - Low-Interest Financing - Longer Payment Terms - Warranties and Service Contracts - Psychological Discounting Promotional-pricing strategies are often a zero-sum game. If they work, competitors copy them and they lose their effectiveness. If they don't work, they waste money that could have been put into other marketing tools, such as building up product quality and service or strengthening product image through advertising.

Geographic Pricing (Cash, Counter-trade, Barter)

In geographical pricing, the company decides how to price its products to different customers in different locations and countries. Many buyers want to offer other items in payment, a practice known as counter-trade. - Barter - The buyer and seller directly exchange goods, with no money and no third party involved. - Compensation Deal - The seller receives some percentage of the payment in cash and the rest in products. - Buyback Arrangement - The seller sells a plant, equipment, or technology to another country and agrees to accept as partial payment products manufactured with the supplied equipment. - Offset - The seller receives full payment in cash but agrees to spend a substantial amount of the money in that country within a stated time period.

Chapter Summary

1. Despite the increased role of non-price factors in modern marketing, price remains a critical element of marketing. Price is the only element that produces revenue; the others produce costs. Pricing decisions have become more challenging, however, in a changing economic and technological environment. 2. In setting pricing policy, a company follows a six-step procedure. It selects its pricing objective. It estimates the demand curve, the probable quantities it will sell at each possible price. It estimates how its costs vary at different levels of output, at different levels of accumulated production experience, and for differentiated marketing offers. It examines competitors' costs, prices, and offers. It selects a pricing method, and it selects the final price. 3. Companies usually set not a single price, but rather a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, and other factors. Several price-adaptation strategies are available: (1) geographical pricing, (2) price discounts and allowances, (3) promotional pricing, and (4) discriminatory pricing. 4. Firms often need to change their prices. A price decrease might be brought about by excess plant capacity, declining market share, a desire to dominate the market through lower costs, or economic recession. A price increase might be brought about by cost inflation or over-demand. Companies must carefully manage customer perceptions when raising prices. 5. Companies must anticipate competitor price changes and prepare contingent responses. A number of responses are possible in terms of maintaining or changing price or quality. 6. The firm facing a competitor's price change must try to understand the competitor's intent and the likely duration of the change. Strategy often depends on whether a firm is producing homogeneous or non-homogeneous products. A market leader attacked by lower-priced competitors can seek to better differentiate itself, introduce its own low-cost competitor, or transform itself more completely.

In This Chapter, We Will Address the Following Questions

1. How do consumers process and evaluate prices? 2. How should a company set prices initially for products or services? 3. How should a company adapt prices to meet varying circumstances and opportunities? 4. When should a company initiate a price change? 5. How should a company respond to a competitor's price change?

Initiating Price Increases

A successful price increase can raise profits considerably. If the company's profit margin is 3 percent of sales, a 1 percent price increase will increase profits by 33 percent if sales volume is unaffected. A major circumstance provoking price increases is Cost Inflation. Companies often raise their prices by more than the cost increase, in anticipation of further inflation or government price controls,in a practice called Anticipatory Pricing. Another factor leading to price increases is Overdemand. It can increase price in the following ways, each of which has a different impact on buyers. - Delayed quotation pricing - the company does not set a final price until the product is finished or delivered. This pricing is prevalent in industries with long production lead times, such as industrial construction and heavy equipment. - Escalator clauses - the company requires the customer to pay today's price and all or part of any inflation increase that takes place before delivery. An escalator clause bases price increases on some specified price index. Escalator clauses are found in contracts for major industrial projects, such as aircraft construction and bridge building. - Unbundling - the company maintains its price but removes or prices separately one or more elements that were part of the former offer, such as free delivery or installation. - Reduction of discounts - the company instructs its sales force not to offer its normal cash and quantity discounts. Given strong consumer resistance, marketers go to great lengths to find alternate approaches that avoid increasing prices when they otherwise would have done so. Here are a few popular ones: - Shrinking the amount of product instead of raising the price. - Substituting less-expensive materials or ingredients. - Reducing or removing product features. - Removing or reducing product services, such as installation or free delivery. - Using less-expensive packaging material or larger package sizes. - Reducing the number of sizes and models offered. - Creating new economy brands (generic).

Differentiated Pricing

Companies often adjust their basic price to accommodate differences in customers, products, locations, and so on. Price Discrimination - occurs when a company sells a product or service at two or more prices that do not reflect a proportional difference in costs. - In first-degree price discrimination,the seller charges a separate price to each customer depending on the intensity of his or her demand. - In second-degree price discrimination, the seller charges less to buyers of larger volumes. - In third-degree price discrimination, the seller charges different amounts to different classes of buyers, as in the following cases: Customer-Segment Pricing - Different customer groups pay different prices for the same product or service. Product-Form Pricing - Different versions of the product are priced differently, but not proportionately to their costs. Image Pricing - Some companies price the same product at two different levels based on image differences. Channel Pricing - Coca-Cola carries a different price depending on whether the consumer purchases it in a fine restaurant, a fast-food restaurant, or a vending machine. Location Pricing - The same product is priced differently at different locations even though the cost of offering it at each location is the same. Time Pricing - Prices are varied by season, day, or hour. Although some forms of price discrimination (in which sellers offer different price terms to different people within the same trade group) are illegal, price discrimination is legal if the seller can prove its costs are different when selling different volumes or different qualities of the same product to different retailers. Predatory pricing—selling below cost with the intention of destroying competition—is unlawful, though. For price discrimination to work, certain conditions must exist. - First, the market must be segment-able and the segments must show different intensities of demand. - Second, members in the lower-price segment must not be able to resell the product to the higher-price segment. - Third, competitors must not be able to undersell the firm in the higher-price segment. - Fourth,the cost of segmenting and policing the market must not exceed the extra revenue derived from price discrimination. - Fifth, the practice must not breed customer resentment and ill will. - Sixth, of course, the particular form of price discrimination must not be illegal

INITIATING AND RESPONDING TO PRICE CHANGES

Companies often need to cut or raise prices.

ADAPTING THE PRICE

Companies usually do not set a single price but rather develop a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, delivery frequency, guarantees, service contracts, and other factors. Here we will examine several price-adaptation strategies: - Geographical pricing, - Price discounts and allowances, - Promotional pricing, and - Differentiated pricing.

A Changing Pricing Environment

Here is a short list of how the Internet allows sellers to discriminate between buyers,and buyers to discriminate between sellers. Buyers can: - Get instant price comparisons from thousands of vendors. - Name their price and have it met. - Get products free. Sellers can: - Monitor customer behaviour and tailor offers to individuals. - Give certain customers access to special prices. - Negotiate price in online auctions and exchanges or even in person.

Step 5: Selecting a Pricing Method

MARKUP PRICING TARGET-RETURN PRICING In target-return pricing, the firm determines the price that yields its target rate of return on investment. PERCEIVED-VALUE PRICING Perceived Value - is made up of a host of inputs, such as the buyer's image of the product performance, the channel deliverables, the warranty quality, customer support, and softer attributes such as the supplier's reputation, trustworthiness, and esteem. VALUE PRICING Value Pricing: They win loyal customers by charging a fairly low price for a high-quality offering. Value pricing is thus not a matter of simply setting lower prices; it is a matter of re-engineering the company's operations to become a low-cost producer without sacrificing quality, to attract a large number of value-conscious customers. GOING-RATE PRICING In going-rate pricing,the firm bases its price largely on competitors' prices. AUCTION-TYPE PRICING These are the three major types of auctions and their separate pricing procedures: - English Auctions (Ascending Bids) - Dutch Auctions (Descending Bids) - Sealed-Bid Auctions

Step 2: Determining Demand

PRICE SENSITIVITY ESTIMATING DEMAND CURVES Most companies attempt to measure their demand curves using several different methods. - Surveys - Price experiments - Statistical analysis PRICE ELASTICITY OF DEMAND

Introduction

Price is the one element of the marketing mix that produces revenue; the other elements produce costs. Prices are perhaps the easiest element of the marketing program to adjust; product features, channels, and even communications take more time. Price also communicates to the market the company's intended value positioning of its product or brand. A well-designed and marketed product can command a price premium and reap big profits. But new economic realities have caused many consumers to pinch pennies, and many companies have had to carefully review their pricing strategies as a result. Pricing decisions are clearly complex and difficult, and many marketers neglect their pricing strategies. Holistic marketers must take into account many factors in making pricing decisions—the company,the customers,the competition,and the marketing environment. Pricing decisions must be consistent with the firm's marketing strategy and its target markets and brand positionings. In this chapter, we provide concepts and tools to facilitate the setting of initial prices and adjusting prices over time and markets.

Step 6: Selecting the Final Price

Pricing methods narrow the range from which the company must select its final price. In selecting that price, the company must consider additional factors, including the impact of other marketing activities, company pricing policies, gain-and-risk-sharing pricing, and the impact of price on other parties. IMPACT OF OTHER MARKETING ACTIVITIES The final price must take into account the brand's quality and advertising relative to the competition. These findings suggest that price is not necessarily as important as quality and other benefits. COMPANY PRICING POLICIES The price must be consistent with company pricing policies. Yet companies are not averse to establishing pricing penalties under certain circumstances. Many companies set up a pricing department to develop policies and establish or approve decisions. The aim is to ensure that salespeople quote prices that are reasonable to customers and profitable to the company. GAIN-AND-RISK-SHARING PRICING Buyers may resist accepting a seller's proposal because of a high perceived level of risk. The seller has the option of offering to absorb part or all the risk if it does not deliver the full promised value IMPACT OF PRICE ON OTHER PARTIES How will distributors and dealers feel about the contemplated price? If they don't make enough profit,they may choose not to bring the product to market. Will the sales force be willing to sell at that price? How will competitors react? Will suppliers raise their prices when they see the company's price? Will the government intervene and prevent this price from being charged? U.S. legislation states that sellers must set prices without talking to competitors: Price-fixing is illegal.

Consumer Psychology and Pricing

Purchase decisions are based on how consumers perceive prices and what they consider the current actual price to be—not on the marketer's stated price. REFERENCE PRICES When examining products, however, they often employ reference prices, comparing an observed price to an internal reference price they remember or an external frame of reference such as a posted "regular retail price." Clever marketers try to frame the price to signal the best value possible. e.g. $10 a week membership fee for 12 month $520 lock-in contract. PRICE-QUALITY INFERENCES Many consumers use price as an indicator of quality. When information about true quality is available, price becomes a less significant indicator of quality. When this information is not available,price acts as a signal of quality. Some brands adopt exclusivity and scarcity to signify uniqueness and justify premium pricing. PRICE ENDINGS Many sellers believe prices should end in an odd number. Another explanation for the popularity of"9"endings is that they suggest a discount or bargain, so if a company wants a high-price image, it should probably avoid the odd-ending tactic. Prices that end with 0 and 5 are also popular and are thought to be easier for consumers to process and retrieve from memory.

Step 1: Selecting the Pricing Objective

SURVIVAL Companies pursue survival as their major objective if they are plagued with overcapacity, intense competition, or changing consumer wants. As long as prices cover variable costs and some fixed costs, the company stays in business. Survival is a short-run objective; in the long run,the firm must learn how to add value or face extinction. MAXIMUM CURRENT PROFIT They estimate the demand and costs associated with alternative prices and choose the price that produces maximum current profit, cash flow, or rate of return on investment. MAXIMUM MARKET SHARE They believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest price, assuming the market is price sensitive. The following conditions favour adopting a market-penetration pricing strategy: (1) The market is highly price sensitive and a low price stimulates market growth; (2) production and distribution costs fall with accumulated production experience; and (3) a low price discourages actual and potential competition. MAXIMUM MARKET SKIMMING Companies unveiling a new technology favor setting high prices to maximize market skimming. Market skimming makes sense under the following conditions: (1) A sufficient number of buyers have a high current demand; (2) the unit costs of producing a small volume are high enough to cancel the advantage of charging what the traffic will bear; (3) the high initial price does not attract more competitors to the market; (4) the high price communicates the image of a superior product. PRODUCT-QUALITY LEADERSHIP A company might aim to be the product-quality leader in the market. Many brands strive to be "affordable luxuries"—products or services characterised by high levels of perceived quality, taste, and status with a price just high enough not to be out of consumers' reach. OTHER OBJECTIVE Whatever the specific objective,businesses that use price as a strategic tool will profit more than those that simply let costs or the market determine their pricing.

Initiating Price Cuts

Several circumstances might lead a firm to cut prices. 1. Excess Plant Capacity 2. The firm needs additional business and cannot generate it through increased sales effort 3. Product Improvement - initiate price cuts in a drive to dominate the market through lower costs. Cutting prices to keep customers or beat competitors often encourages customers to demand price concessions, however, and trains salespeople to offer them. A price-cutting strategy can lead to other possible traps: - Low-quality trap. Consumers assume quality is low. - Fragile-market-share trap. A low price buys market share but not market loyalty. The same customers will shift to any lower-priced firm that comes along. - Shallow-pockets trap. Higher-priced competitors match the lower prices but have longer staying power because of deeper cash reserves. - Price-war trap. Competitors respond by lowering their prices even more, triggering a price war.

Step 3: Estimating Costs

TYPES OF COSTS AND LEVELS OF PRODUCTION a company's costs take two forms, fixed and variable. Fixed Costs - also known as overhead,are costs that do not vary with production level or sales revenue. Variable Costs - vary directly with the level of production. Total Costs - consist of the sum of the fixed and variable costs for any given level of production. Average Cost - is the cost per unit at that level of production; it equals total costs divided by production. Management wants to charge a price that will at least cover the total production costs at a given level of production. ACCUMULATED PRODUCTION TARGET COSTING Costs change with production scale and experience.They can also change as a result of a concentrated effort by designers, engineers, and purchasing agents to reduce them through target costing.