Chapter 14: Pricing Concepts for Establishing Value

competitive parity

A firm's strategy of setting prices that are similar to those of major competitors.

sales orientation

A company objective based on the belief that increasing sales will help the firm more than will increasing profits.

Describe how to calculate a product's break-even point.

Because the break-even point occurs when the units sold generate just enough profit to cover the total costs of producing those units, it requires knowledge of the fixed cost, total cost, and total revenue curves. When these curves intersect, the marketer has found the break-even point.

Explain price elasticity.

Changes in price generally affect demand; price elasticity measures the extent of this effect. It is based on the percentage change in quantity divided by the percentage change in price. Depending on the resulting value, a market offering can be identified as elastic, such that the market is very price sensitive, on inelastic, in which case the market cares little about the price.

What are the five C's of pricing?

Company objectives, customers, costs, competition, and channel members.

How does one calculate the break-even point in units?

Divide the fixed costs by the contribution per unit (price per unit minus variable cost per unit).

Explain the difference between EDLP and high/low pricing.

EDLP saves search costs of finding lowest overall prices, and high/low provides the thrill of the chase for the lowest price.

gray market

Employs irregular but not necessarily illegal methods; generally, it legally circumvents authorized channels of distribution to sell goods at prices lower than those intended by the manufacturer.

contribution per unit

Equals the price less the variable cost per unit. Variable used to determine the break-even point in units

Indicate the four types of price competitive levels.

In a monopoly setting either one firm controls the market and sets the price or many firms compete with differentiated products rather than on price. Monopolisitc competition occurs when there are many firms competing for customers in a given market but their products are differentiated. In an oligopolistic competitive market, a few firms dominate and tend to set prices according to a competitor-oriented strategy. Finally, pure competition means that consumers likely regard the products offered by different companies as basic substitutes, so the firms must work hard to achieve the lowest price point, limited by the laws of supply and demand.

What is the difference between elastic versus inelastic demand?

In general, the market for a product or service is price sensitive (or elastic) when the price elasticity is less than -1, that is, when a 1% decrease in price produces more that a 1% increase in the quantity sold. In an elastic scenario, relatively small changes in price will generate fairly large changes in the quantity demanded. The market for a product is generally viewed as price insensitive (or inelastic) when its price elasticity is greater than -1, that is, when a 1% decrease in price results in less that a 1% percent increase in quantity sold. Generally, if a firm must raise prices, it is helpful to do so with inelastic products or services because in such a market, fewer customers will stop buying or reduce their purchases.

price elasticity of demand

Measures how changes in a price affect the quantity of the product demanded; specifically, the ratio of the percentage change in quantity demanded to the percentage change in price.

horizontal price fixing

Occurs when competitors that produce and sell competing products collude, or work together, to control prices, effectively taking price out of the decision process for consumers.

pure competition

Occurs when different companies sell commodity products that consumers perceive as substitutable; price usually is set according to the laws of supply and demand.

oligopolistic competition

Occurs when only a few firms dominate a market.

price war

Occurs when two or more firms compete primarily by lowering their prices.

substitute products

Products for which changes in demand are negatively related; that is, a percentage increase in the quantity demanded for product A results in a percentage decrease in the quantity demanded for product B.

complementary products

Products whose demand curves are positively related, such that they rise or fall together; a percentage increase in demand for one results in a percentage increase in demand for the other.

Identify the four types of company objectives.

Profit oriented, sales oriented, customer oriented, and competitor oriented.

inelastic

Refers to a market for a product or service that is price insensitive; that is, relatively small changes in price will not generate large changes in the quantity demanded.

income effect

Refers to the change in the quantity of a product demanded by consumers due to a change in their income.

price

The overall sacrifice a consumer is willing to make--money, time, energy--to acquire a specific product or service.

cross-price elasticty

The percentage change in demand for product A that occurs in response to a percentage change in price of product B.

break-even point

The point at which the number of units sold generates just enough revenue to equal the total costs; at this point, profits are zero.

price fixing

The practice of colluding with other firms to control prices.

List pricing practices that have the potential to deceive customers.

There are almost as many ways to get into trouble by setting or changing a price as there are pricing strategies and tactics. Some common legal issues pertain to advertising deceptive prices. Specifically, if a firm compares a reduced price with a regular or reference price, it must actually have sold that product or service at the regular price. Bait and switch is another form of deceptive price advertising, where sellers advertise items for a very low price without the intent really to sell any at that price. In many states, advertising the sale of products priced below the retailer's cost also constitutes a form of bait and switch. Collusion among firms to fix prices is always illegal.

fixed costs

Those costs that remain essentially at the same level, regardless of any changes in the volume of production.

variable costs

Those costs, primarily labor and materials, that vary with production volume.

prestige products or services

Those that consumers purchase for status rather than functionality.

Explain the difference between a price skimming and a market penetration pricing strategy.

When firms use a price skimming strategy, the product or service must be perceived as breaking new ground or customers will not pay more than what they pay for other products. Firms use price skimming to signal high quality, limit demand, recoup their investment quickly, and/or test people's price sensitivity. Moreover, it it easier to price high initially and then lower the price than vice versa. Market penetration, in contrast, helps firms build sales and market share quickly, which may discourage other firms from entering the market. Building demand quickly also typically results in lowered costs as the firm gains experience making the product or delivering the service.

premium pricing

A competitor-based pricing method by which the firm deliberately prices a product above the prices set for competing products to capture those consumers who always shop for the best or for whom price does not matter.

customer orientation

A company objective based on the premise that the firm should measure itself primarily according to whether it meets its customers' needs.

competitor orientation

A company objective based on the premise that the firm should measure itself primarily against its competition.

What common pricing practices are considered to be illegal or unethical?

Deceptive reference prices, loss leader pricing, bait and switch.

profit orientation

A company objective that can be implemented by focusing on target profit pricing, maximizing profits, or target return pricing.

status quo pricing

A competitor-oriented strategy in which a firm changes prices only to meet those of competition.

bait-and-switch

A deceptive practice of luring customers into the store with a very low advertised price on an item (the bait), only to aggressively pressure them into purchasing a higher priced model (the switch) by disparaging the low priced item, comparing it unfavorably with the higher priced model, or professing an inadequate supply of the lower priced item.

predatory pricing

A firm's practice of setting a very low price for one or more of its products with the intent to drive its competition out of business; illegal under both the Sherman Antitrust Act and the Federal Trade Commission Act.

market penetration strategy

A growth strategy that employs the existing marketing mix and focuses the firm's efforts on existing customers. Set the initial price low for the introduction of the new product or service.

target return pricing

A pricing strategy implemented by firms less concerned with the absolute level of profits and more interested in the rate at which their profits are generated relative to their investments; designed to produce a specific return on investment, usually expressed as a percentage of sales.

target profit pricing

A pricing strategy implemented by firms when they have a particular profit goal as their overriding concern; uses price to stimulate a certain level of sales at a certain profit per unit.

high/low pricing

A pricing strategy that relies on the promotion of sales, during which prices are temporarily reduced to encourage purchases.

maximizing profits

A profit strategy that relies primarily on economic theory. If a firm can accurately specify a mathematical model that captures all the factors required to explain and predict sales and profits, it should be able to identify the price at which its profits are maximized.

List the four pricing orientations.

A profit-oriented pricing strategy focuses on maximizing, or at least reaching a target, profit for the company. A sales orientation instead sets prices with the goal of increasing sales levels. With a competitor-oriented pricing strategy, a firm sets its prices according to what its competitors do. Finally, a customer-oriented strategy determines consumers' perceptions of value and prices accordingly.

everyday low pricing (EDLP)

A strategy companies use to emphasize the continuity of their retail prices at a level somewhere between the regular, non sale price, and the deep-discount sale prices their competitors may offer.

price skimming

A strategy of selling a new product or service at a high price that innovators and early adopters are willing to pay in order to obtain it; after the high-price market segment becomes saturated and sales begin to slow down, the firm generally lowers the price to capture (or skim) the next most price sensitive segment.

Describe the difference between an everyday low price strategy (EDLP) and a high/low strategy.

An everyday low pricing strategy is maintained when a product's price stays relatively constant at a level that is slightly lower than the regular price from competitors using high/low strategy and is less frequently discounted. Customers enjoy an everyday low pricing strategy because they know that the price will always be about the same and a better price than the competition. High/low pricing strategy starts out with a product at one (higher) price, and then discounts the product. This strategy first attracts a less price sensitive customer who pays the regular price and then a very price sensitive customer who pays the low price.

What is the difference between a market penetration strategy and a price skimming pricing strategy?

Firms using a market penetration strategy set the initial price low for the introduction of the new product or service. Price skimming is a strategy that occurs in many markets, and particularly for new and innovative products or services, and involves consumers being willing to pay a higher price to obtain the new product or service.

Explain the relationship between price and quantity sold.

Generally, when prices go up, quantity sold goes down. Sometimes, however--particularly with prestige products and services--demand actually increases with price.

vertical price fixing

Occurs when parties at different levels of the same marketing channel (e.g., manufacturers and retailers) collude to control the prices passed on to consumers.

monopolistic competition

Occurs when there are many firms that sell closely related but not homogeneous products; these products may be viewed as substitutes but are not perfect substitutes.

monopoly

One firm provides the product or service in a particular industry.

elastic

Refers to a market for a product or service that is price sensitive; that is , relatively small changes in price will generate fairly large changes in the quantity demanded.

substitution effect

Refers to consumers' ability to substitute other products for the focal brand, thus increasing the price elasticity of demand for the focal brand.

experience curve effect

Refers to the drop in unit cost as the accumulated volume sold increases; as sales continue to grow, the costs continue to drop, allowing even further reductions in the price.

demand curve

Shows how many units of a product or service consumers will demand during a specific period at different prices.

loss leader pricing

Takes the tactic of leader pricing one step further by lowering the price below the store's cost.

break-even analysis

Technique used to examine the relationships among cost, price, revenue, and profit over different levels of production and sales to determine the break-even point.

price discrimination

The practice of selling the same product to different resellers (wholesalers, distributors, or retailers) or to the ultimate consumer at different prices; some, but not all, forms are illegal.

reference price

The price against which buyers compare the actual selling price of the product and that facilitates their evaluation process.

manufacturer's suggested retail price (MSRP)

The price that manufacturers suggest retailers use to sell their merchandise.

total cost

The sum of fixed costs plus variable costs.