GS MKT 306 CH 10 Pricing

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.

Another way to determine the break-even point is by using a graph (often called a cost-volume-profit, CVP, graph).

Figure 10.2 illustrates break-even analysis by this method. It plots lines representing a product's estimated revenues and costs. The point at which the two lines intersect is the break-even point. Notice that the graph also shows the influence of fixed and variable costs. The fixed costs remain flat, while variable costs increase as the amount of sales increases. Once unit sales pass the break-even point, the firm begins to generate a profit. (Also, sales lower than the break-even point result in losses to the firm.)

Prestige pricing is

a pricing tactic that involves pricing a product higher than competitors to signal that it is of higher quality. 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.

Revenue is the

result of the price charged to customers multiplied by the number of units sold.

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.

The NYOP model is attractive to marketers for various reasons: It has

the potential to help suppliers reduce inventory (fewer unsold airline tickets and hotel rooms), while generating additional revenue (for the airline or hotel). It also potentially provides savings to consumers.

In addition to technological and economic factors, firms seeking additional revenue and profits by marketing their products globally encounter

unique challenges related to global pricing, including the gray market, tariffs, and dumping.

Price Setting Process

1. Define the pricing objectives 2. Evaluate demand 3. Determine the costs 4. Analyze the competitive price environment 5. Choose a price 6. Monitor and evaluate the effectiveness of the price

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.

2 of 6 Price Setting Process : 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. 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.

5 of 6 Price Setting Process : 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.

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. Let's look at an example of how markup pricing does not capture value for our lawn chair.

As we have discussed, different customers place different values on the products they purchase. Imagine we have four target customers who personally value the lawn chair at $10, $14, $15, and $20, respectively. The information about the value that each customer places on the lawn chair comes from the firm's marketing research and salespeople. Table 10.2 shows how much profit margin the firm would earn on each lawn chair if it uses a 20 percent markup. 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.

fixed costs

Costs that remain constant and do not vary based on the number of units produced or sold 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.

variable costs

Costs that vary depending on the number of units produced or sold Variable costs include things such as raw material, sales commissions, and delivery costs.

Ken Sage Senior Carrier Sales Coordinator J.B. Hunt Transport Services, Inc.

Describe your job. My main responsibility is to bridge the gap between customers and our partner carriers. Each and every day, I am on the phone with our partner carriers negotiating prices. Our primary goal is to drive down the cost of transportation so we can maximize profit. What has been the most important thing in making you successful at your job? I believe I have been successful in my job because of my competitive spirit. Not only am I competing on an individual level, but I also am competing as a team within my branch and, more importantly, competing against other companies as part of J.B. Hunt. What advice would you give soon-to-be graduates? Think outside the box and don't be scared to try something new. There are going to be thousands of recent graduates just like you looking for the same jobs that we all first think of when applying after graduation. Don't be scared to look into the trucking company that you think hires only dispatchers and drivers. Remember, there are always things going on behind the scenes you may not know about until you look into them. Don't be scared to do something you are not familiar with. You may stumble across a career in pricing that you didn't know was out there. What do you consider your personal brand to be? I am a yes-man. Many people think that being a yes-man means being a pushover. To me, being a yes-man means thinking nothing is impossible. I learned a long time ago that it is too easy to say, "No, I can't do that." I always look for ways to make things happen. Every problem has a solution; you just have to work to find it. I believe by being a yes-man I have shown that I am willing to work hard, never give up, and always try to solve the problem.

Marketers must also take online competitors into account. This applies to both in-store and online-only items. For example, retailer Brookstone separated its team of pricing employees into an in-store group and an online-commerce group.

Every day the online team scours competitors' websites to check the prices of their online electronics and then adjusts the prices of thousands of Brookstone's online-only items accordingly.

Firms that use odd pricing still need to consider the impact of price elasticity of demand at odd-pricing points.

For example, would a fast-food restaurant that offers a value meal for $4.95 see any decrease in sales if it raised the price to $4.99? Probably not, and the resulting $0.04 increase could result in significant profits over millions of customer transactions throughout the year.

Marketers also should consider how competitors might respond to their pricing. Pricing can resemble a game of chess. You should always be thinking about what your opponents' future moves might be.

How a firm reacts to a change in a competitor's prices depends on whether the competitor is a stronger or weaker rival and whether the price reduction is cost-justified. For example, if a weaker competitor initiates a price decrease that would leave your firm unable to cover its costs if you met the price, you are likely to ignore the competitor's price cut and maintain your current pricing. However, if the price cut is initiated by a stronger competitor and is cost-justified, your firm will likely reduce prices to defend its existing customer base and market share.

Keep these factors in mind when, after you graduate, you negotiate the price an organization is willing to pay you as an employee. If the price to hire you is too high, the company you are interviewing with may hire someone else.

However, if you ask for a lower salary than what the company is willing to pay, you have sacrificed initial earnings potential. This, in turn, could affect your earnings for years to come if your raises are based on percentage increases in your initial salary.

Industry structure plays an important role in analyzing the competitive price environment. For example, in a market structure in which there are a large number of buyers and sellers, as is the case for our car dealership, the pricing impact of any single firm will be fairly small.

However, in an industry in which a small number of firms compete, firms will typically match the price of competitors. A common example is the multibillion-dollar wireless phone industry, in which only a few major competitors fight for market share. Marketers at AT&T, Verizon Wireless, and other firms compete on nonprice strategies, such as rollover minutes and better product features.

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.

Inelastic demand example To see these concepts at work in the real world, consider how the principle applies to cost increases at Netflix. In 2011, Netflix raised prices on its DVD and online streaming services by over 50 percent.5 The company received a significant amount of negative publicity, but fewer than 4 percent of paid subscribers stopped using the service. Thus, demand was inelastic.

If we plug these percentages into our fictional car example, look at what the equivalent results would be for the car dealership: March: 1,000 cars sold × $20,000 (average price for new cars) = $20,000,000 April: 960 cars sold (4% decrease) × $30,000 (50% price increase) = $28,800,000

3 of 6 Price Setting Process : 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. While marketers must understand a firm's costs to set prices effectively, costs should never totally dictate price. Strategic pricing requires firms to integrate costs into other aspects of the marketing mix, including what value the customer places on the product and the price environment in the industry.

The Robinson-Patman Act (also called the Anti-Price Discrimination Act) requires sellers to charge everyone the same price. 1936 the United States government passed the Robinson-Patman Act as an amendment to the Clayton Antitrust Act of 1914.

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. • A firm can lower prices for certain customers if a competitor undercuts the originally quoted price. • 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.

underpricing

One of the most common mistakes in modern pricing is charging someone less than they are willing to pay Because revenue is simply the number of units sold multiplied by the price per item, marketers too often make the mistake of setting prices too low in an effort to increase the units-sold side of the equation. Instead, they need to consider all of the other factors that contribute to the value a customer places on a product.

seasonal discounts

Price reductions given to customers purchasing goods or services out of season 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.

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.12 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.

1 of 6 Price Setting Process : 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.

Pricing in today's market isn't as easy as applying economic theory. To start, external environmental forces can significantly affect market demand. For example, during the recession, demand for houses declined significantly. The economic situation reduced demand to such a degree that house prices in many parts of the country declined by more than 15 percent from their previous values.

Those who wanted to sell homes—existing homeowners and banks holding foreclosed properties—often were not willing to reduce prices to the point where would-be buyers were willing and able to buy.

Two of the most common and effective strategies for raising prices are unbundling and escalator clauses.

Unbundling 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. In general, unbundling provides value for customers who are focused on a specific price point rather than the complete product offering. Escalator Clauses An 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. Firms that decide to use escalator clauses should make them as transparent as possible. They should specify whether price adjustments will be made at fixed intervals (e.g., quarterly, semi-annually, or annually) or only at the expiration of the contract.

1 of 6 Price Setting Process : Define the Pricing Objectives : volume maximization

Volume maximization is designed to maximize volume and revenue for a firm. is the process of setting prices low to encourage a greater volume of purchases. Because the goal is to gain a large market share due to the low price, the strategy associated with volume maximization is often referred to as penetration pricing. For a volume-maximization strategy to work over the long term, the firm must have a significant cost or resource advantage over competitors.

Mark Duckworth Chief Executive Officer and Founder Optus Inc.

What has been the most important thing in making you successful at your job? One of the most important factors has been creating genuine relationships with employees, customers, and vendors. Also, I personally believe that sales success is usually created because of purchasing efforts beforehand. Lastly, I am always optimistic, focused on the possibilities ahead but trying to balance that with a healthy dose of realism. Never underestimate the value of tenacity and a positive attitude. What advice would you give soon-to-be graduates? Get a robust education as a solid foundation and consider graduate school if it will help give you an advantage in your specific area of focus. If you have dreams of becoming an entrepreneur and starting a business, consider working in a related industry for a year or two, but pursue starting the business early in your career. It is much easier to focus on making such an investment before you have a family and your risk tolerance changes. How is marketing relevant to your role at Optus? I am the CEO of a marketing- and sales-driven company, so it is extremely relevant to me. Our ability to be successful starts with our ability to have great products. We must price them in a way that provides maximum value to us and our customers. Finally, we must promote and deliver them in a way that brings value to those customers. We work in a very competitive industry, and our ability to make good strategic marketing decisions and execute on those strategies is essential to our success in the short and long term. What do you consider your personal brand to be? I provide unique value not offered in the marketplace by the competition: a passion to out-serve any of my competitors and to create genuine relationships with others. What step in the price-setting process do you think is most problematic for marketers? I would say it is determining costs. I have seen too many businesses over the years that don't have an accurate picture of how much each unit of product actually costs.

price fixing

When two or more companies collude to set a product's price Price fixing is illegal under the Sherman Antitrust Act of 1890 and the Federal Trade Commission Act An example of price fixing occurred when British Airways and its rival Virgin Atlantic agreed to simultaneously increase their fuel surcharges.22 Over the next two years, fuel surcharges increased from an average of 5 British pounds a ticket to over 60 pounds. When the price-fixing scheme was reported by Virgin, British Airways was punished with record fines: The British Office of Fair Trading fined the airline £121.5 million, and the U.S. Department of Justice levied an additional $300 million fine. Virgin was given immunity for reporting the collusion and was not fined.

Price elasticity example Consider the following example: Suppose a car dealership reduces prices on its entire stock of new inventory by 10 percent. You would expect the quantity of cars demanded, and consequently sales, to increase. But by what percentage would sales increase?

Would they increase enough to offset the decrease in price? If the dealership reduced prices by 10 percent but sold only 4 percent more cars in the following month, it would be worse off than it was initially, as the following equations illustrate: Sales before price cut: 1,000 cars sold × $20,000 (average price for new cars) = $20,000,000 Sales after price cut: 1,040 cars sold (4% increase) × $18,000 (10%) = $18,720,000

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. In recent years, the removal of tariffs due to international agreements has caused some countries to switch to nontariff barriers, such as anti-dumping laws, to protect their local industries. The Indian silk producers declared that Chinese producers must be dumping the products. Indian companies complained that the unreasonably low price of Chinese silk left them only two options: lose customers to the Chinese producers or sell their own silk at a loss.

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. To solve this problem, some sports leagues have implemented yield management systems, offered by firms like SAP and Oracle. Such systems enable marketers to estimate price elasticity of tickets and then use dynamic pricing to maximize revenue. As a result, teams are able to sell tickets for a specific event at the price that reflects the true value to fans.

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.

Profit margin is the

amount a product sells for above the total cost of the product itself.

Organizations must ensure that the prices they set generate profit after accounting for both fixed and variable costs. A $20,000 car might generate

an $800 per-car profit for the dealership after all of the fixed costs are accounted for. However, if the dealership offers its salespeople a 5 percent commission ($1,000) on each new car sold, the dealership would actually lose money on sales of the car. Marketing professionals must watch costs closely and set prices accordingly to avoid such scenarios.

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. For example, a Walmart store in the city of Nanning priced Nescafe coffee at $5.44, discounted from an advertised price of $6.67; in fact, the original price was $5.66. In the United States, deceptive pricing is regulated by the Federal Trade Commission (FTC). Cases may be prosecuted by a state attorney general or by a district attorney at the state or local level.

When undertaking either strategy, unbundling or escalator clauses, the firm must take the time to

clearly explain the price change to customers. Even if customers are not happy with the change, at least they will understand why it's being done. If the firm doesn't communicate the purpose of the increase effectively, customers who are unwilling to accept the increase may use social media platforms or other word-of-mouth strategies to protest against the new policies.

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.

Marketers should also be aware of how the external environment affects price elasticity. For example, research suggests that

consumers tend to be more sensitive to prices during difficult economic times.6 In addition, inflation has been shown to lead to substantially higher price elasticities over the past several decades.7

Inelastic demand is

demand for which a given percentage change in price results in a smaller percentage change in quantity demanded.4 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.

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. In equation form:

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.

Instead of just seeking to identify reference prices, marketers can also seek to

establish reference prices for consumers. Even if a firm doesn't seek to establish reference prices as Apple does, its marketers should always question what reference prices potential customers will compare the firm's prices with.

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 × Price Profits = Revenue − Costs

As indicated in an earlier chapter, the World Trade Organization (WTO) is the

forum that regulates trade among participating companies. The WTO hasn't classified dumping as illegal. Therefore, many countries enact their own laws to curb the strategy. As they develop an international pricing strategy, companies must monitor how anti-dumping laws affect similar companies in the industry and calculate the potential impact of anti-dumping regulations on sales.

Such success aside, price bundling has come up against increased customer resistance in some industries. Cable television providers

have always relied on a bundling strategy in which customers have to buy a package of channels rather than paying individually for the channels they want. In recent years, as the price of those channel bundles kept rising, the practice has come under fire. Consumer advocates point out that, if you're watching only 10 channels, why should you pay for 85? They've begun pushing for a system of à la carte pricing in the hope that such a move will drive down prices for consumers.

Now compare the markup pricing scenario to a research-based approach that considers the competitive price environment. The cost of producing the product is still $10 per lawn chair. Marketing research has told the company that competitors charge $16 or more per chair and that many customers value their lawn chairs at $15 or more. As a result, the firm sets its price at $15. Table 10.3 shows the firm's improved profit margin outcomes using this alternate pricing strategy.

he firm ends up with one fewer sale because customer #2 perceives the price to be too high. But the firm has a total profit of $10, which is close to 50 percent higher than the $6 total profit the firm earned using a simple markup strategy.

Pricing is a critical component of a successful global marketing strategy. Historically, companies have set prices for products sold internationally

higher than the same products sold domestically. However, technological advancements and Internet access throughout the world have made global pricing more transparent and, in many cases, more competitive.

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.

1 of 6 Price Setting Process : Define the Pricing Objectives : 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.

1 of 6 Price Setting Process : Define the Pricing Objectives : 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. For profit maximization to work, firms must use the other marketing-mix elements to ensure the product is produced, delivered, and promoted in a way that clearly differentiates it from competing alternatives. Profit maximization is designed to maximize profits on each unit sold.

Pricing is one of the most watched and regulated marketing activities because

it directly affects the financial viability of both organizations and individuals.

Gray-market goods can be a boon for consumers, allowing them to obtain

legally produced items for less than they could normally. However, gray-market goods cut into a firm's revenue and profits, leaving marketers looking for ways to control and repress such activity. The increasingly interconnected nature of world economies makes gray-market exchanges easier than ever. Firms find it difficult, if not impossible, to track exactly how much of their products sell in this manner.

As they set international prices, U.S. marketers must be cognizant of the potential for gray-market exchanges. If they price their products significantly

lower in foreign countries than in the domestic market, they may open the door to gray-market buyers. Using modern technology, those buyers will buy the products internationally and then sell them in the United States at a price that undercuts the standard rate paid by U.S. consumers.

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."

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. The general formula for calculating markup price is: Markup price = Unit cost of product + (Desired % return × Unit cost)

In this section, we'll discuss some of the ethical issues marketers may face as they seek to set prices for their products. These issues include

price discrimination, price fixing, predatory pricing, and deceptive pricing.

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. There are usually two ways to purchase products: à la carte (individually) or as a bundle. Conventional wisdom says that à la carte pricing benefits the customer, and bundled pricing benefits the firm. Undoubtedly, price bundling simplifies things for marketers. The company can sell the same bundle to everyone, which results in reduced advertising and selling costs.

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.

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.

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.

Tariffs are

taxes on imports and exports between countries. Fruits and vegetables are popular goods on which to place tariffs, in some countries reaching to over 25 percent.18 The goal of tariffs is usually to protect domestic industries from lower-priced foreign competition. The international pricing strategy of any U.S. firm must take into account the potential tariffs foreign countries will place on its goods. Marketers typically prefer targeting international markets that have low (or no) tariffs. Countries with which the U.S. has international trading agreements also offer lower-tariff markets. For example, the North American Free Trade Agreement (NAFTA) enables companies and consumers in those countries to trade without tariffs.

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. Pricing is one of the most important strategic decisions a firm faces: 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.

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.

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.

Ultimately, marketers want to charge as much as they possibly can, as long as

the consumer still perceives value in the product at that price.

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. 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 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.

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. Price sensitivity varies from product to product and from consumer to consumer. As Table 10.1shows, a number of factors influence price sensitivity. For example: Table 10.1 Factors Influencing Price Sensitivity • Size of expenditure Customers are less sensitive to the prices of small expenditures which, in the case of households, are defined relative to income. • Shared costs Customers are less price-sensitive when some or all of the purchase price is paid by others. • Switching costs Customers are less sensitive to the price of a product if there is added cost (both monetary and nonmonetary) associated with switching to a competitor. • Perceived risk Customers are less price-sensitive when it is difficult to compare competing products and the cost of not getting the expected benefits of a purchase is high. • Importance of end-benefit Customers are less price-sensitive when the product is a small part of the cost of a benefit with high economic or psychological importance. • Price-quality perceptions Customers are less sensitive to a product's price to the extent that price is a proxy for the likely quality of the purchase. • Reference prices Customers are more price-sensitive the higher the product's price relative to the customers' price expectation. • Perceived fairness Customers are more sensitive to a product's price when it is outside the range that they perceive as "fair" or "reasonable." • Price framing Customers are more price-sensitive when they perceive the price as a "loss" rather than as a forgone "gain." They are more price-sensitive when the price is paid separately rather than as part of a bundle.

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. At the break-even point, it will earn no profit and it will suffer no loss. Note an important point: Break-even analysis analyzes only the costs of the sales. It does not reflect how demand may be affected at different price levels; in other words, it doesn't measure price sensitivity. Just because the firm will break even selling 5 widgets at a price of $200 each doesn't mean customers are willing to buy widgets at that price.

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.

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. This type of long-term aggressive pricing strategy could be considered an attempt to create a monopoly. It is therefore illegal under U.S. law. However, predatory pricing is difficult to prove. The Supreme Court has ruled that the victim must prove that the company being accused of predatory pricing (the chain supermarket, in our example) would be able to recoup its initial losses by charging higher prices later on, once it has driven others out of business.

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. Chances are you routinely compare the prices of almost everything you buy, from textbooks to coffee to gasoline. Marketers can capitalize on this tendency by identifying the reference prices of their targeted consumers when setting their own prices. Reference prices matter to marketers because consumers are typically more price-sensitive the higher a product's price is relative to expectations.

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. Once a company estimates fixed and variable costs, it can incorporate them into a break-even analysis.

The 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.

Salespeople can be a valuable tool when identifying reference prices. In most cases, salespeople have the most direct contact with customers and thus a good sense of what customers are willing to pay. Salespeople who have developed relationships with customers often

understand the most attractive price points; they can leverage the quality of that relationship to obtain higher profits. Marketers should work closely with the sales force to understand how high they can price a product before customers stop considering the product a good value. Customer surveys, focus groups, and other forms of marketing research also are helpful in understanding how consumers view a certain product and how much they are willing to pay for it.

Social media are influencing the prices consumers see when

when buying products online. Some organizations also offer different online prices based on what type of mobile device consumers use to access the site or where consumers are located. Such pricing differences are legal, as long as they do not stifle competition. However, marketers should be careful about pricing differences: Studies suggest that over 75 percent of consumers say they would be bothered if they knew that someone paid a lower price for the same product.

black market

which refers to the illegal buying and selling of products outside of sanctioned channels

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.

6 of 6 Price Setting Process : 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.

4 of 6 Price Setting Process : 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.