Chapter 9

How is cost-plus pricing computed?

(UNIT COST)/(1-X%) -X is intended return

large-scale consumer bidding systems

(e.g., online) are open auctions in which all bids are transparent to all participants, and the bidding proceeds in a sequential manner.

Describe how pricing is a cue to quality

-Counter to the anticipated economic effect of higher prices causing a decrease in demand, for some products and services, higher prices can make a purchase seem more appealing. -For some purchases, customers use price as a cue to quality, implicitly reasoning that the brand can command a high price because its quality is so good. -That argument assumes a belief in the efficiency of the marketplace, yet many studies have demonstrated that there is no correlation between price and quality for most product categories. -A price's role as a cue is so strong that prices are known to contribute to the formation of expectations prior to a purchase. A price is a clear, tangible cue, and higher prices set higher expectation

Describe a conjoint analysis:

-More than surveys, marketing managers' favorite tool to study pricing is conjoint. -In a conjoint study, customers are shown products with various combinations of features and attributes, price being one of them. -What's neat about the conjoint approach is that customers aren't ever directly asked about price, so the method obviates the customer's natural inclination to say, "I want to pay less." We also know that customers are indeed willing to pay more for what they want, and the conjoint technique helps detect what those attributes are. Customers are asked for a simple judgment: Which one of these do you like most, next most, etc.? And they can do this easily and quickly. We derive from the conjoint analyses the attributes that customers seek, including what price they're willing to pay. (We'll do a conjoint in Chapter 15.) The analysis allows us to infer their price sensitivities.

What are the Cs of marketing that affect pricing?

-The costs inherent to the company help determine the low price point -the customer's sense of the product's value help determine the high price point -what the competition charges helps determine a sensible intermediate price point.

Describe the different kinds of pricing

-The lowest sensible price is set by covering costs and then adding some margin. -The highest possible price is set by figuring out just how much a customer is willing to pay and pricing near that mark. -Competitive pricing is somewhere in between, using competitors' prices as a starting point and adjusting from there.

Describe coupons

-They're more temporary or ethereal because by definition they're relevant only to the segment of customers who are coupon clippers. It's likely that price is more important to these customers than brand image, so the concern of temporary price drops reflecting poorly on the brand is less of an issue for coupons. -Coupons are big business. By some estimates, 350 billion are available yearly in the United States alone, with an average value of about $1.

Describe price differentials:

-can reflect different product functionality, but different prices can also reflect mere cosmetic differences. -A high price point almost becomes the sought feature, as when basic Visa cards can be obtained with no annual fee, but American Express charges $2,500 for their elite Black card.

What are some other reasons why prices vary?

-pricing typically varies over the course of a product's life cycle. -Willingness to pay varies across segments, so a firm might offer differential prices to those different segments. -Prices can have multiple elements that can be tweaked

Describe using survey data:

-several marketing research tools can be used to assess a customer's willingness to pay (WTP). -Still, the items can convey information. Some people simply aren't interested in the banking service no matter what the price, so their scores would look something like Q1 = 2 or 3, and Q2 = 1 or 2. At the other extreme, some people might be really keen for the service, so their scores would be Q1 = 6 or 7 and Q2 = 5 or 6. A final segment might be sort of interested in the banking service, if the price was right; their scores would be something like Q1 = 4 or 5 and Q2 = 3 or 4

What provides the company a mechanism for obtaining value back from customers?

price

What are some factors that drive sensitivity?

-Customers are more price sensitive (price is more elastic for them) when they don't care that much about the purchase, purchase category, or brand. If their preferences aren't strong, they feel no brand loyalty. -Price sensitivity is greater when the item is a luxury good rather than a necessity, when many substitutes are available, when the purchase is a relatively big one (compared to a customer's household income). -Finally, it's no surprise that price sensitivity is generally greater for customers with lower household incomes. -Price sensitivity should increase when price information is easily available to customers to compare across competing brands. Thus the Internet is having an interesting effect on prices for many items. Price comparisons are easier online than driving from store to store, and in particular shopping bots such as Bizrate.com facilitate easy and quick comparisons.

Describe how consumers process absolute numbers and relative numbers differently

-Say you receive some email coupons for Office Max. Your Office Depot is much closer. Would you drive to the Office Max for $15 off a box of printer toner (that costs $49)? What about if the coupon was for $15 off a new tablet (that costs $199)? -In both cases, the coupon offers the same face value, a $15 discount, but for the toner, $15 off is a larger proportion ($49 vs. $199), so it seems like a better deal. Rationally, we'd assess the absolute value; but there's a logic to assessing the relative value as well.

Describe elasticity and price

Another popular interpretation of elasticity is from a consumer's point of view: If there is a price drop (or increase), just how much does demand (units sold) increase (or decrease)? If demand is barely affected, the demand is inelastic; if demand bounces around, it's stretchy and elastic.

Describe non linear pricing

Some prices are set using a so-called two-part tariff: A customer pays some amount for one part of the service (usually a fixed fee, such as an entry fee at a night club or a ticket to enter a theme park) and another amount for another part of the service (usually a charge per unit of usage, such as drinks at the club, or food, T-shirts, and memorabilia at the theme park).

english auctions

bids increase among the players over time. -As the price surpasses the value to a customer, that customer drops out of the auction, and, with time, whoever remains standing pays the last, highest bid, to obtain the item.

Describe quantity discounts:

-Another completely legitimate and accepted form of segmentation pricing is to offer quantity discounts—the more you buy, the more you save! -Customers are used to seeing these offers, they can compute the average price per unit, and demand falls off with higher prices. None of that surprises us. In the column labeled $, it looks like we should go for the "3 for $30" because $960 is the biggest number. However, the per unit sales registered in the last column shows us that we would do best to use the "2 for $25" deal.

Describe price fluctuations

-Another element of changing prices is a price promotion, through temporary price cuts or the issuance of coupons. These techniques are reliable in generating a modest short-term uptick in sales, but there are also equally predictable side effects that aren't as positive. -First, competitors can imitate price cuts immediately. So whatever market share increase in volume you were aiming for gets negated, and you (and your competitors) have shot yourself in the foot by squeezing your own margins. Second, price drops attract disloyal customers, and why not? Customers are savvy and often price sensitive, and they are quickly trained to buy when brands are on sale. Indeed, one motivation for your price drop was probably to widen the circle of customers who will purchase your brand and perhaps come back with future repeat purchasing. -Another dirty little secret is that price discounts are often not profitable. Yes, demand increases with deeper discounts, but only to a point. And even if the temporary price discount is profitable in the very short run, it may come at the expense of longer-run profitability. -A final cause for concern of occasional price fluctuations is the deleterious effect on the image of the brand.

Where do low price points come from?

-Cost-plus pricing: mark up above average cost -Loss leaders: sell below cost to bring in customers who will purchase other products -Market penetration: price low to attract volume >>>>Early in the product life cycle to generate buzz and demand >>>>Late in the product life cycle to milk profits before the brand dies -Nearly predatory: price low enough to discourage competitors

What factors drive demand?

-Demand goes up as a function of a customer's desire: the more customers there are who want the brand, or the more any customer wants the brand. -Demand goes up with enhanced perceptions of the product's benefits or brand image. -Demand goes up if competitors' brands aren't great, i.e., if there are few good substitutes, or they're priced even higher.

Describe pricing as high as you can:

-Determine customers' willingness-to-pay, then price right below that sensitivity point -Price high for margins, not worrying about volume (the 'market skimming' strategy often used early in the life cycle of a high-end brand to heighten its sense of exclusivity) -Prestige or status pricing: price high for image appeal -Price high due to real quality differences or true rarity

Describe why prices end in 9

-Fifth, there's a reason the prices of many things—groceries, books, clothing, cars—end in 9, such as $4.99 or $49.99 or $4,999.99. Wouldn't you think that their whole number counterparts ($5, $50, $5,000) would be easier to understand and advertise? Well, it's reliably known that $4.99 is far more attractive than $5, much more than the penny difference. Why? Apparently, because we read from left to right, we process and internalize the "4" before we hit the ".99." So we're thinking, "Oh, the price is $4-ish," not, "Wow, the price is $5!"

What are the issues with low prices?

-First, how do we determine whether costs are covered? To address this basic question, we will compute a variety of break-evens—simple math computations that determine how many units we have to sell to make money. -The second pricing issue is whether low prices are a constant strategic choice, such as everyday low price providers (EDLPs) who position themselves around good value in the minds of consumers. Or should we pulse the market with price fluctuations, offering and rolling back temporary price discounts. We discuss break-evens first.

Describe what each elasticity means:

-If E > 1, as in the left plot, demand is said to be elastic. Price and revenue go in opposite directions: With a price drop, revenues shoot up; with a price increase, revenues fall off. -If 0 ≤ E < 1, as in the right plot, demand is inelastic. Revenue follows price in the same direction: If price goes up, revenue goes up; if price goes down, so do revenues. -If E = 1, demand is said to be unitary. Prices goes up or down, but revenues remain about the same.

Describe competitive strategy and game theory

-In addition to concerns about the impact of price points or price changes on our own brand image, marketers must consider that the competition won't just sit idly by while we enjoy increased sales due to a price cut. Marketers frequently use game theory to try to estimate the likely results of various actions, most frequently price cuts and competitive response. -Say a competitor such as the market leader initiates action by dropping prices. We must then decide whether to cut prices also in order to convey to our customers our equitable value or to maintain prices and emphasize to customers that our brand is based on nonprice features. Further, do we offer a line extension to diminish the brand confusion but risk cannibalization? -Game theory is just a structured way to think about the behavior of interdependent players, like two (or more) firms.

Describe how to determine price sensitivity

-In markets that are fairly stable (e.g., mature products with few technological introductions), marketing managers might see that their price sensitivity estimates are also fairly stable. If that's the case, we can turn the elasticity or price sensitivity (PS) equation inside out. The price changes are under our control. If PS is largely stable, we can plug that estimate in and solve for a decent forecast as to what the sales change might be. -This estimate would be very useful in budgeting. If we have no good estimate for price sensitivity, or if the recent historical data move around a lot, we should get current estimates.

Describe yield or demand management:

-In particular, services are said to be perishable, meaning that there is no such thing as storing inventory or excess capacity. All the customers rush a system when they want to be served, and, if they overload capacity, it can be a problem for the service provider, and the quality of service can deteriorate. So another example of segmentation pricing is to vary prices during peak and nonpeak seasons. -Whether a customer experiences a price or time shift, it's important that the company manage perceptions of fairness. With regard to time, FIFO (first-in/first-out) seems universally fair in queuing, but customers also tend to be understanding when there are exceptions (e.g., larger parties wait longer to be seated at restaurants). -These practices of yield management are popular in services, many of which are characterized by high fixed costs and lower variable costs (e.g., airlines, hotels, rental cars) to enhance revenue and capacity utilization. The systems have also gotten very complex, but an advantage of this approach to pricing is that it is based on the market, not on costs per se.

Describe pricing and the 4Ps?

-Like any of the 4Ps, a firm needs to revisit the strategic questions about pricing from time to time. Two contrasting strategies are referred to as pricing for market penetration or skimming. If you want to disperse your brand quickly and widely throughout the marketplace, that is, penetrate the market, the brand would be priced low at the time of its introduction to stimulate sales and to encourage trial and word of mouth. This approach is intended to capture a large market share. It is a little risky because, if many customers immediately start buying your brand, you better be ready. The product better be good (no beta testing, thank you!), and your production capacity and your channels better be ready to serve. With time, the price is usually raised. As the brand reaches maturity and finds its segments, the product is adorned with more features that customers care about, etc. -In contrast, market skimming is a strategy where a high price is set because the company is seeking profit margin, not volume. The only customers who will buy this brand at a high price are the ones who really want it. Think of your digit-head friends who want the latest in software or hardware and who are willing to pay (a lot) for it. Think of the authors you like so much that you buy their new books in hardback, rather than waiting a few months for the lower-priced paperback or e-book to come out. Over time, the price is usually lowered to make the brand accessible to more customer segments. -Regardless of the starting point—whether high (skimming) or low (penetration)— modifications can occur as the product matures. For example, as segments develop, different product lines could be priced differently. As the brand matures, a drop in prices might restimulate sales, but, if a firm believes in the brand, sales would also be restimulated by maintaining (or raising) prices and by adding features and benefits. Finally, when the brand has one foot in the ground, prices often tumble because the firm wants to dump inventory.

Describe the legality of pricing

-No "price fixing" (two or more firms agree on what price to charge, to reduce the effect of competition that drives prices (and profits) down; Sherman Antitrust Act 1890 and Federal Trade Commission Act 1914). -No "price fixing" (two or more firms agree on what price to charge, to reduce the effect of competition that drives prices (and profits) down; Sherman Antitrust Act 1890 and Federal Trade Commission Act 1914). -No "predatory pricing" (cannot price "unreasonably" low to drive out competition; Unfair-Trade Laws). Yet grocery stores routinely sell certain products cheaply, e.g., below costs, call them "loss leaders," count on their attracting traffic to the store. Also, huge companies routinely drop prices to discourage new competitors (then lawyers define "unreasonable"). -No "price discrimination" to consumers or channel partners (cannot charge different prices to different customers for the same product; Robinson-Patman Act 1936). Different prices must reflect a difference in costs, e.g., the loyal segment gets a deal because it costs less to process them, or they're charged more because they require more services. -No "deceptive pricing," a.k.a. "bait and switch" (cannot mislead customers by advertising one product, but only making another, usually more expensive, product available for purchase, or by posting one price, but scanning and ringing up another).

Describe an example of break even for a service:

-Services are tricky because they are notoriously disproportionately high in variable costs. As a result, the cost numbers will move faster with an increase in demand. -So let's consider a slightly different scenario. Say we have another friend who is considering a business with a storefront where consumers can bring their tablets and a service is provided in which the customer's favorite software is loaded, the machine customized, new apps put on, etc. We'll keep the fixed cost constant from the previous example just for some consistency and to be able to compare across a good and a service to see the effect of the service and its inherent variable costs. -shows the variable costs. (In the previous example of the portfolios, there were variable costs as well but they were smaller than for this tablets example.) It costs the store's staff time to load the software (given their salaries and their time, say that averages out to about $30 a tablet), and the store must maintain legal licensing fees on a variety of software packages (say this is roughly $3 a tablet). -In Figure 9.7, the first row reminds us of the fixed costs, and the next rows capture the variable costs, with the totals at the bottom. Figure 9.8 shows possible income, depending on price and demand. Figure 9.9 contains the differences, or profits. This analysis could be refined, using continuous numbers rather than our rougher numbers (15, 30, etc.). Similarly, the prices charged could be assessed in a more refined manner, with a continuous scale ($0 to 500 a unit), but again the discrete price points gives us a sense of the breakeven problem. -In Figure 9.9, let's take a look at the money we'd make (or not). First, note that $30 is just a totally ridiculous baseline. We'd lose money fast, and, as we service more machines, we'd lose even more money. If we charged $50, we're still not doing well. Increase the charge a little more to $100, and we can make money if we customize 30 e-book readers or more.

Describe mood inductions of pricing

-Temporary price discounts are not only an economic lever. Customers think they're smart shoppers when they get a good deal. People feel good when they get something for a price that's better than usual. The experience is about feelings of happiness, pride, appreciation, confidence, etc., not about money per se.

Describe auctions:

-The idea is that there isn't a fixed price; rather, the price is negotiated between the buyer and seller. In a sense, auctions have always been around, and they are interesting in part because they continue to grow in popularity online. -Buyers have strength if they account for a significant portion of the seller's sales or if they have multiple options for meeting their procurement needs. Sellers have strengths when products are in short supply, in high demand, or differentiated, or simply when the economic times are good. -Prices stay down when there is high supply relative to demand, intense brand competition, etc. Prices are boosted by controlled supply, high product value, product differentiation, high buyer dependency on suppliers, high switching costs, etc. -The defining characteristic of an auction is that the price point isn't set or fixed, nor is it even negotiable between a seller and one buyer. Rather, buyers/bidders compete to obtain the item. -The defining characteristic of an auction is that the price point isn't set or fixed, nor is it even negotiable between a seller and one buyer. Rather, buyers/bidders compete to obtain the item. As in any marketplace, sellers want to yield high prices, and buyers want low prices. There is a particularly odd sense of efficiency in that whoever bids the highest is very probably indeed the customer who values the item the most.

Describe how consumers keep track of spending through mental accounting

-They also rationalize compensatory or future purchasing. Just as we speak in financial terms of discounting future sales for the time value of money, we do this mentally also. If we buy a case of wine for an upcoming party, the current purchase is seen as an investment, not spending. And the later consumption of that wine at the party is seen as "free" because it's not tied closely in time to when it was purchased. This concept of an immediate vs. future cost-benefit analysis has also been used to explain why we don't do things in the short term that are good for us (as individuals or collectively as a society) in the long term (e.g., engage in healthy behaviors, or sound environmental ones). We simply pay less attention to future consequences. -Another form of mental accounting is how we think of categories of money. You might think that money is money. It's fungible: Money spent on one household item comes from the same budget as a competing item. However, we often classify money as if it were nonfungible, meaning that we categorize our purchases and budget within the categories. -A relatively new phenomenon is the customer processing of alternative currencies—no, not the euro vs. the yuan. Rather, all the zillions of companies' loyalty programs are generating additional currencies, which usually have fairly transparent monetary values (and can be traded or given away). The airline mileage programs are the most mature, and it is not infrequent to see customers behave in seemingly inconsistent manners, e.g., refusing to pay for business class seats but having no problem redeeming points for upgrades.

Describe the compromise effect in pricing

-To illustrate, consider the following: One group of consumers was given the choice of buying two professional basketball tickets for $250 or two tickets several rows up for $200. On an order of 2:1, most (67%) went with the cheaper seats ($200). -Next, an entirely fresh sample of consumers was offered two tickets for $200, two slightly better seats for $250, or two even better seats for $300. About 10% went for $300. Of the remaining 90%, the preference for the $200 and $250 reverses from the first scenario: 2:1 with 60% of the sample asking for the $250 seats and 30% for the cheap $200 seats. -"compromise" because the middle choice in the second choice set is an attractive compromise between the two extremes. The seats are probably better than the $200 seats, but the tickets are not as expensive as the $300 ones. It's thought that this effect occurs because ultimately, whether we can articulate it explicitly or not, we apparently believe in an efficient market. That is, if a company charges more, we assume that they must be providing something better or more of something. If they were not, eventually consumers would figure it out and the company would have to drop prices. Note that the company doesn't really care how many $300 tickets it sells; it introduces the $300 tickets to make the former high price of $250 seem more enticing.

Describe referent pricing

-When we evaluate a product's price to determine whether we think the price being charged is fair, we compare the price to some reference, either an externally available price or an internally (mentally) stored price. Sometimes a product's price tag will offer this comparison to encourage the consumer to believe that the current price is a good deal, such as, "MSRP is $49.99, now available for $35.99!" Other external reference forms are popular during sales; e.g., "Now $14.99, regularly priced at $35.00!" Or some companies position themselves as having an EDLP (everyday low price) when they state, "Our price $34.99, compare at $45.00!" Whenever we refer to someone experiencing sticker shock, the idea is that the price on the sticker is much higher than the referent. -reference price point can also be internal. The expectation regarding how much the product costs comes from a variety of sources, including the buyer's experience. For example, if the product being purchased is one that consumers buy a lot, they would be familiar with the product's typical price. Internal references can, of course, be faulty or not very relevant; e.g., how much you paid for your last car (even though that was 5 years ago, and it was an economy car vs. the luxury model you're now buying). Internal references can also be based on inferences, e.g., is the store an upscale one, leading us to believe that perhaps the prices of the store's service are a bit inflated? Or do the high prices imply high-quality brands?

Describe B2B Pricing

B2B pricing tools are the same, even if they're called different things: -Trade discounts and price discrimination: discounts for cash, quantity, bulk, seasonality -Trade allowances: cut prices to intermediaries based on the functions they perform, such as participation in advertising or sales support programs -Differential prices based on geography: based on distance and transportation costs -Transfer prices: pricing passed along through the channel networ -Forms of barter: payments in goods, services, or buying agreements rather than in cash

Describe pricing in the middle

Mid-point prices come from seeing what competitors price at, and adjusting according to corporate and brand strategy: -Price higher if you offer more benefits or brand equity, wish to enhance image -Price a little lower if you wish to be perceived as good value

contribution per unit to fixed costs

The last term, [(Price - Variable costs)] in the break even analysis

Describe a break even goal in terms of linear functions:

The number of units sold forms the horizontal axis, and money (both costs and revenue) form the vertical axis. The first horizontal line in the graph itself shows the fixed costs, steady across all number of units (of course, it's fixed). The line labeled "Total costs" includes these fixed costs and have an increasing slope because they also reflect the variable costs, which increase with numbers of units produced and sold. The "Revenue" line is our income, and the point at which this line intersects the "Total costs" line is our breakeven point, as we just computed, right at 30.

Why do marketers have to understand how customers perceive prices and price changes, like promotions?

To know how prices will be received and affect demand

Break-even analysis

a means of figuring out how many units you'd have to sell before you make back your costs -If marketers are long-term focused, as in relationship marketing via CRMs, they might be willing to not quite break even on the first purchase because they expect to break even shortly thereafter. The early hits on the company are investments in the customers. -A breakeven can be computed in terms of number of units sold or monetary values.

dutch auctions

begin high and prices drop over time (though not below the seller's reservation price). -When the price finally drops low enough that a buyer is willing to buy the item at that price, the item is sold and the auction is concluded.

elasticity

defined as the proportion change in quantity compared to the proportion change in price -defined by the slopes.

Describe the contextual frame of pricing

in which information is expressed matters—the spin, if you will. Imagine you're planning a spring break trip with a friend, and you've narrowed your choices down to two vacation packages: One is priced at $499, the other at $599 with a $100 discount when you book. Which choice seems more appealing? In either case, your credit card is going to be charged $499. But the second choice starts at a higher price, so it's not unusual to assume that maybe the trip package is of better quality (e.g., nicer hotel, more activities). You'll feel like a smart shopper by getting more value, a $599 trip for just $499. $499 is $499, but it's not irrational when we have a rationale.

scanner data

include indicators of which brands are bought, the quantities bought, the shelf price of the objects, the paid price (e.g., whether a coupon was used), the price of competitors' brands that week, a flag for whether any of the brands were featured in local weekend newspaper flyers or in end-of-aisle displays in the store, advertising exposures to panel households, etc

reservation price

the point of indifference at which you say, "If you raise the price, forget it, I won't buy; if you drop the price, okay, I will." -reservation price is really a good estimate of the customer's willingness to pay. Naturally this price cap varies by segment and product category.

True or false? If a firm prices its brand too low, they could probably raise prices and pull in more money (better margins and profitability).

true

True or false? If instead, variable costs are relatively high, the strategic objective is to maximize per unit margins. (We can't bring down price in hopes to build sales volume because volume drives up variable costs.)

true

True or false? If the brand is priced too high, generally sales drop off. So if prices are adjusted downward, then the volume of sales would pick up, and, again, the company could pull in more money (better demand and greater volume in unit sales).

true

True or false? If your fixed costs (including marketing, advertising, R&D, depreciation, etc.) are high relative to variable costs (which include labor or unit components), the strategic objective is to maximize sales volume (to spread the fixed costs over as many units as possible).

true

True or false? Pricing is not just about making money. It's as important as any of the other Ps in terms of sending a signal to customers, competitors, and collaborators regarding the positioning and image of the brand.

true