Marketing Ch 19
Zero Percent Financing
To get consumers into automobile showrooms, manufacturers sometimes offer zero percent financing, which enable purchasers to borrow money to pay for new cars with no interest charge. This tactic creates a huge increase in sales, but is not without its costs. A five-year interest-free car loan typically represents a loss of more than $3,000 for the car's manufacturer.
Pay What You Want
To many people, paying what you want or what you think something is worth is a very risky tactic. Obviously, it would not work for expensive durables like automobiles. Imagine someone paying $1 for a new BMW! Yet this model has worked in varying degrees in digital media marketplaces, restaurants, and other service businesses. One of your authors has patronized a restaurant close to campus that asks diners to pay what they think their meals are worth. After several years, the restaurant is still in business. The owner says that the average lunch donation is around $8 for lunch. Social pressures can come into play in a "pay what you want" environment because an individual does not want to appear poor or cheap to his or her peers.
The Legality of Price Strategy
Unfair Trade Practices Price Fixing Price Discrimination Predatory Pricing
Pricing Objectives
Need to be specific, attainable, and measurable Categories Profit oriented Sales oriented Status quo
SINGLE-PRICE TACTIC
A merchant using a single-price tactic offers all goods and services at the same price (or perhaps two or three prices). Dollar Tree and Dollar Bill chains sell everything for $1 or less. Such a strategy can be quite successful. The 280-store chain 99 Cents Only sold for $1.6 billion.*
Rebates
A rebate is a cash refund given for the purchase of a product during a specific period. The advantage of a rebate over a simple price reduction for stimulating demand is that a rebate is a temporary inducement that can be taken away without altering the basic price structure. A manufacturer that uses a simple price reduction for a short time may meet resistance when trying to restore the price to its original, higher level.
Price Fixing
Agreement between two or more firms on the price they will charge for a product
sales maximization
Companies with the objective of maximizing sales ignore profits, competition, and the marketing environment as long as sales are increasing. Maximization of cash should never be a long-run objective because cash maximization may mean little or no profitability. Without profits, a company cannot survive.
Break-Even Pricing
Determines what sales volume must be reached before total revenue equals total costs Provides a quick estimate of: How much the firm must sell to break even How much profit can be earned if a higher sales volume is obtained Limitations Hard to determine if a cost is fixed or variable Ignores demand
Tactics for Fine-Tuning the Base Price
Discounts, Allowance, Rebates, and Value-based pricing Other Pricing tactics The base price is the general price level at which the company expects to sell a good or service. The general price level is correlated with the pricing policy: above the market, at the market, or below the market. The final step is to fine-tune the base price. Fine-tuning techniques include discounts, geographic pricing, and other pricing tactics.
The Nature of Demand
Lower the price, higher the demand for a product or service and vice versa At higher prices, supply increases as manufacturers earn more capital and vice versa
Predatory Pricing
Practice of charging a very low price for a product with an intent to drive competitors out of business or out of a market
Status Quo Pricing
The third basic price strategy a firm may choose is status quo pricing. Recall that this pricing strategy means charging a price identical to or very close to the competition's price. Although status quo pricing has the advantage of simplicity, its disadvantage is that the strategy may ignore demand or cost or both. If the firm is comparatively small, however, meeting the competition may be the safest route to long-term survival. Animated Figure:
Seasonal discounts
apply when certain merchandise is bought out of season. A gambled price discount is based upon the outcome of a probabilistic gamble.
Cash discounts
are offered in return for prompt payment of a bill
Functional discounts (Trade discounts)
are offered when channel intermediaries perform a service for the manufacturer.
Coupons
A coupon is a discount offered via paper, a card, a printable web page, or an electronic code. U.S. marketers issue more than 310 billion coupons each year, 2.75 billion of which are redeemed. This redemption rate of less than 1 percent has held steady for many years.* Insurance companies often raise copays on expensive drugs to get consumers to switch to low-cost alternatives. However, drug manufacturers have begun advertising "no copay" coupons for certain high-price drugs, leaving the insurance companies to pay the balance. The pharmaceutical industry now spends about $7 billion a year on copay coupons and discount cards.* When patients have a copay of $50, they are four times less likely to fill a prescription.* Drug companies say that they are just making their drugs more affordable for consumers, but are not offering similar discounts to insurance providers. Some pharmacy benefit managers, such as Express Scripts and CUS Health, have begun banning drugs from their programs because of high costs and coupon copays. United Health Group, the nation's largest health insurer, now bans 35 specialty drugs including growth hormones and medicines for pulmonary hypertension and infertility.*
The Demand determinant of price
After marketing managers establish pricing goals, they must set specific prices to reach those goals. The price they set for each product depends mostly on two factors: the demand for the good or service and the cost to the seller for that good or service. When pricing goals are mainly sales oriented, demand considerations usually dominate. Other factors, such as distribution and promotion strategies, perceived quality, needs of large customers, the Internet, and the stage of the product life cycle, can also influence price.
Profit Maximization
Although profit maximization aims at setting prices for a large total revenue, it does not always signify unreasonably high prices. Both price and profits depend on the type of competitive environment the firm faces and the product's perceived value.
What is Price?
Amount that is given up in an exchange to acquire a good or service Effects Measure of sacrifice Information cue Value is based upon perceived satisfaction Reasonable price means perceived reasonable value at the time of the transaction Price means one thing to the consumer and another to the seller. To the consumer, the price is the cost of something; to the seller, price is the source of profits. Marketing mangers find the task of setting prices a challenge. Price plays two roles in the evaluation of product alternatives: as a measure of sacrifice and as an information cue. Sacrifice can be money used to get a good or service or the time lost while waiting to acquire the good or service. Higher price can convey higher product quality and the prominence and status of the purchaser. Consumers are interested in obtaining a reasonable price, which means a perceived reasonable value at the time of the transaction.
Competition, Price Matching and Customer Loyalty
Competition varies during the product life cycle, of course, and so at times it may strongly affect pricing decisions. Although a firm may not have any competition at first, the high prices it charges may eventually induce another firm to enter the market. Competition varies during the product life cycle, of course, and so at times it may strongly affect pricing decisions. Although a firm may not have any competition at first, the high prices it charges may eventually induce another firm to enter the market. Fast food giants McDonald's, Burger King, and Wendy's have been going head-to-head for years in their efforts to attract cost-conscious customers. A recent McDonald's promotion, McPick2, offered two items for two dollars. One way to counter a competitor's prices is price matching. The four biggest British supermarket chains all offer price matching guarantees, ensuring that customers cannot save money by shopping elsewhere. When a shopper pays more for an item than it would cost at another store, he or she receives a voucher saying, "Your shopping would have been cheaper elsewhere, so here is a voucher for the difference."* On the face of it, it seems that fierce competition is driving down prices. And this is often the case. However, economists warn that price matching may actually result in higher prices. A car dealership worried about losing clients to a lower-priced rival may offer a price matching guarantee. The hope is that the guarantee will persuade customers not to shop around; they will always pay the lowest price available by sticking with the usually higher-priced dealership. As a result, cutting prices no longer wins the competitor new business. Instead, it means lower profits on existing sales. Thus, the competitor will likely conclude that prices and profit margins are better left high. Recall the British supermarket chains that give vouchers as a way to meet their price-matching guarantees. In order for a voucher to have value, the customer must return to the same supermarket chain. In this way, price matching can be a tool for building customer loyalty. And the more return customers the store gains over time, the greater the sales volume. Companies attempt to build customer loyalty in many ways. One approach is to offer discounts to regular patrons. This can lead to a loyalty-discount cycle, whereby loyal customers receive deeper discounts that in turn further increase their customer loyalty—resulting in downward pressure on the issuing firm's long-term pricing strategy.* Discounts can be an excellent tool to build customer loyalty, but care must be taken not to compromise profit goals. There are many other creative and industry-specific ways to reward loyalty. For example, airlines use unfilled seats to award free travel and upgrades to loyal customers. Some companies give branded gifts to drive customer loyalty. Hotel chains build databases on their most loyal customers so they can automatically serve the room and amenity preferences of frequent customers.
The Relationship of Price to Quality
Consumers rely on high price as a predictor of good quality when a purchase decision involves uncertainty Higher prices increase expectation and set a reference point against which people can evaluate their consumption experiences Online Vivre vs. Bluefly Vivre is a luxury lifestyle catalog and website. Visit Vivre.com and review the product offerings. Pick a product and then see if you can get it cheaper at Bluefly.com, a luxury brand discounter. What luxury brands are offered on both sites? How do the prices compare? Can you identify tiers of luxury brands? As mentioned at the beginning of the chapter, when a purchase decision involves uncertainty, consumers tend to rely on a high price as a predictor of good quality. Reliance on price as an indicator of quality seems to occur for all products, but it reveals itself more strongly for some items than for others. Among the products that benefit from this phenomenon are coffee, aspirin, shampoo, clothing, furniture, whiskey, education, and many services. In the absence of other information, people typically assume that prices are higher because the products contain better materials, because they are made more carefully, or, in the case of professional services, because the provider has more expertise. Researchers have found that price promotions of higher priced, higher quality brands tend to attract more business than do similar promotions of lower priced and lower quality brands. Higher prices increase expectation and set a reference point against which people can evaluate their consumption experiences. Passengers on expensive full-service airlines like Delta, United, and American complain about service failures much more often than do customers of low-cost airlines like Spirit, Southwest, and Easy Jet. A bad experience with a higher priced product or service tends to increase the level of disappointment. Finally, products that generate strong emotions, such as perfumes and fine watches, tend to get more "bang for the buck" in price promotions.*
Elasticity of Demand
Consumers' responsiveness or sensitivity to changes in price Elastic demand Situation in which consumer demand is sensitive to changes in price Inelastic demand Situation in which an increase or a decrease in price will not significantly affect the demand for a product Factors that Affect Elasticity Availability of substitutes - When many substitutes are available, it is easy to switch products. This makes demand elastic. Price relative to purchasing power - If a price is so low that it is an inconsequential part of an individual's budget, demand will be inelastic. Product durability - Repairing durable products rather than replacing them prolongs their useful life. Thus, people are sensitive to the price increase, and the demand is elastic. Product's other uses - The greater the number of uses for a product, the more elastic demand tends to be. If a product has only one use, the quantity purchased probably will not vary as price varies.
Markup Pricing
Cost of buying the product from the producer, plus amounts for profit and for expenses not otherwise accounted for To use markup based on cost or selling price effectively, the marketing manager must calculate an adequate gross margin Margin must provide adequate funds to cover selling expenses and profit Markup pricing is the most popular method to establish a selling price. Instead of using the costs of production to set price, markup pricing uses the costs of buying the product from the producer, plus amounts for profit and expenses. The total determines the selling price. Markups are influenced by: Experience Merchandise's appeal to customers Past response to the markup Item's promotional value Seasonality of the good Fashion appeal of the product Product's traditional selling price Competition Keystoning is a method of marking up prices based on experience, with many small retailers doubling the cost. Other factors that influence markups are the merchandise's appeal to customers, past response to the markup, the item's promotional value, the seasonality of the goods, their fashion appeal, the product's traditional selling price, and competition.
Stages in Product Life Cycle
During the introductory stage, prices are set high to recover development costs. Demand originates in the core of the market and is relatively inelastic. As the product enters the growth stage, prices tend to stabilize due to increased product supply from competitors, increased product appeal to a broader market, and decreased costs from economies of scale. Maturity brings about further decreases in price as competition increases and high-cost firms are eliminated. However, distribution channels become a significant cost factor because of the need to offer wide product lines. Usually, only the most efficient manufacturers remain. In the decline stage, price may decrease further until only one firm is left in the market. Prices begin to stabilize at this stage and may even increase as the product moves into the specialty goods category.
The Power of Dynamic Pricing and Yield Management Systems (YMS)
Dynamic pricing: Ability to change prices very quickly in real time Aids brick-and-mortar retailers to compete more efficiently with online alternatives, More and more companies are turning to dynamic pricing to help adjust prices. Yield management system (YMS) Uses complex mathematical software to profitably fill unused capacity by: Discounting early purchases Limiting early sales at discounted prices and overbooking capacity Yield management systems (YMS) were developed in the airline industry to profitably fill unused capacity. YMS has spread beyond the service industries and is being used by companies to set prices based on a number of variables.
How to Set a Price on a Product
Establish Pricing Goals Estimate Demand, Costs and Profits Choose a Price Strategy Fine tune base price with pricing tactics
Free Shipping
Free shipping is another method of lowering the price for purchasers. Zappos, Nordstrom, and L.L. Bean offer free shipping with no minimum order amount. However, since shipping is an expense to the seller, it must be built into the cost of the product. Amazon spends about $6.6 billion on shipping but brings in only about $3.1 billion in payments for shipping.* Amazon, Best Buy, and Gap recently raised their minimum order requirements to receive free shipping. Based on a study of 113 major retailers, a customer must spend an average of $82 on merchandise to qualify for free shipping.*
Bait Pricing
In contrast to leader pricing, which is a genuine attempt to give the consumer a reduced price, bait pricing is deceptive. Bait pricing tries to get consumers into a store through false or misleading price advertising and then uses high-pressure selling to persuade them to buy more expensive merchandise. You may have seen this ad or a similar one: This is bait. When a customer goes in to see the machine, a salesperson says that it has just been sold or else shows the prospective buyer a piece of junk. Then the salesperson says, "But I've got a really good deal on this fine new model." This is the switch that may cause a susceptible consumer to walk out with a $400 machine. The Federal Trade Commission considers bait pricing a deceptive act and has banned its use in interstate commerce. Most states also ban bait pricing, but sometimes enforcement is lax.
Unfair Trade Practices
Laws that prohibit wholesalers and retailers from selling below cost In over half the states, unfair trade practice acts put a floor under wholesale and retail prices. Selling below cost is illegal in some states. Wholesalers and retailers must take a certain minimum percentage markup on their combined merchandise cost and transportation cost. The most common markup figures are 6 percent at the retail level and 2 percent at the wholesale level. If a specific wholesaler or retailer can provide "conclusive proof" that operating costs are lower than the minimum required figure, lower prices may be allowed. The intent of unfair trade practice acts is to protect small firms from retail giants like Walmart and Target, which operate efficiently on razor-thin profit margins. State enforcement of unfair trade practice laws has generally been lax because low prices benefit local consumers. Price fixing and predatory pricing are illegal under the Sherman Act and the Federal Trade Commission Act.
Package Content Reduction
Manufacturers can keep the price and package size the same while reducing the amount of content, thereby increasing the price per ounce or pound.*
Market share
Market share is a company's product sales as a percentage of total sales for that industry. Many companies believe that maintaining or increasing market share is an indicator of the effectiveness of their marketing mix.
The Cost Determinant of Price
Markup Pricing Break-Even Pricing
Satisfactory Profits
Satisfactory profits represent a reasonable level of profits that is consistent with the level of risk an organization faces.
Professional Services Pricing
Professional services pricing is used by people with lengthy experience, training, and often certification by a licensing board—for example, lawyers, physicians, and family counselors. Professionals sometimes charge customers at an hourly rate, but sometimes fees are based on the solution of a problem or performance of an act (such as an eye examination) rather than on the actual time involved. Those who use professional pricing have an ethical responsibility not to overcharge a customer. Because demand is sometimes highly inelastic, such as when a person requires heart surgery to survive, there may be a temptation to charge "all the traffic will bear."
Profit-Oriented Pricing Objectives
Profit-Oriented Pricing Objectives Profit Maximization Satisfactory Profits Target Return on Investment return on investment (ROI) ROI = Net profit after taxes ÷ Total assets Target return on investment (ROI), or the firm's return on total assets, represents a firm's effectiveness in generating profits with the available assets. ROI puts a firm's profits into perspective by showing profits relative to investment. ROI needs to be evaluated in terms of the competitive environment, risks in the industry, and economic conditions.
Price Discrimination
Prohibits: Firms from selling similar commodities at different prices to two or more different buyers within a short time Sellers from offering two buyers different supplementary services Buyers from using their purchasing power to force sellers into granting discriminatory prices or services Defenses provided for a seller charged with price discrimination Cost Market conditions Competition The Robinson-Patman Act provides three defenses for the seller charged with price discrimination. In each case the burden is on the defendant to prove the defense. Cost - A firm can charge different prices to different customers if the prices represent manufacturing or quantity discount savings. Market conditions - Price variations are justified if designed to meet fluid product or market conditions. Examples include the deterioration of perishable goods, the obsolescence of seasonal products, a distress sale under court order, or a legitimate going-out-of-business sale. Competition - A reduction in price may be necessary to stay even with the competition.
Estimate Demand, Cost and Profits
Recall that total revenue is a function of price and quantity demanded and that quantity demanded depends on elasticity. Elasticity is a function of the perceived value to the buyer relative to the price. The types of questions managers consider when conducting marketing research on demand and elasticity are key. Some questions for market research on demand and elasticity are: What price is so low that consumers would question the product's quality? What is the highest price at which the product would still be perceived as a bargain? What is the price at which the product is starting to be perceived as expensive? What is the price at which the product becomes too expensive for the target market? After establishing pricing goals, managers should estimate total revenue at a variety of prices. This usually requires marketing research. Next, they should determine corresponding costs for each price. They are then ready to estimate how much profit, if any, and how much market share can be earned at each possible price. Managers can study the options in light of revenues, costs, and profits. In turn, this information can help determine which price can best meet the firm's pricing goals.
Other Pricing tactics
Single-Price Tactic Flexible Pricing Professional Services Pricing Price Lining Leader Pricing Bait Pricing Odd-Even Pricing Price Building Two-Part Pricing Pay What You Want Package Content Reduction
Other Determinants of Price
Stages in Product Life Cycle Competition, Price Matching, and Customer Loyalty The Impact of Internet and Extranets The Relationship of Price to Quality Following are the other determinants of price: The demand for a product and the competitive conditions tend to change as a product moves through its life cycle. This leads to price changes. Competition varies during the product life cycle. Although a firm may not have competition at first, the high prices it charges may induce other firms to enter the market and sometimes competition can lead to price wars. A competitor's prices can be countered using price matching. Price matching can also be a tool for building customer loyalty. An effective distribution network helps overcome minor flaws in the marketing mix. The Internet, extranets (private electronic networks), and wireless setups allow sellers to collect detailed data about customers, which enable them to tailor products and prices. Pricing is used as a promotional tool to increase consumer interest. Specific pricing demands from large customers such as department stores may affect the profits of the manufacturers. Price promotions of higher priced, higher quality brands and products such as perfumes and fine watches tend to attract more business.
Status Quo Pricing Objectives
Status quo pricing: Maintains existing prices or meets the competition's prices Leads to suboptimal pricing as it ignores: Customers' perceived value of the firm's goods or services Goods or services offered by the competitors Status quo pricing seeks to maintain existing prices or to meet the competition's prices. This category requires little planning and is essentially a passive policy.
Target Return on Investment
Target return on investment (ROI), or the firm's return on total assets, represents a firm's effectiveness in generating profits with the available assets. ROI puts a firm's profits into perspective by showing profits relative to investment. ROI needs to be evaluated in terms of the competitive environment, risks in the industry, and economic conditions.
The Impact of the Internet and Extranets
The Internet, extranets (private electronic networks), and wireless setups are linking people, machines, and companies around the globe—and connecting sellers and buyers as never before. These links are enabling buyers to quickly and easily compare products and prices, putting them in a better bargaining position. At the same time, the technology allows sellers to collect detailed data about customers' buying habits, preferences, and even spending limits so that sellers can tailor their products and prices.
Choose a Pricing Strategy
The basic, long-term pricing framework for a good or service should be a logical extension of the pricing objectives. The marketing manager's chosen price strategy defines the initial price and gives direction for price movements over the product life cycle. The price strategy sets a competitive price in a specific market segment based on a well-defined positioning strategy. Changing a price level from premium to super premium may require a change in the product itself, the target customers served, the promotional strategy, or the distribution channels. A company's freedom in pricing a new product and devising a price strategy depends on the market conditions and the other elements of the marketing mix. If a firm launches a new item resembling several others already on the market, its pricing freedom will be restricted. To succeed, the company will probably have to charge a price close to the average market price. In contrast, a firm that introduces a totally new product with no close substitutes will have considerable pricing freedom. The conventional wisdom is that store brands such as Target's Archer Farms and Kroger's Simple Truth should be priced lower than manufacturer's national brands. In fact, private label products are priced an average of 29 percent less than their national brand counterparts.* However, savvy retailers doing pricing strategy research have found that store brands do not necessarily have to be cheap. When store brands are positioned as gourmet or specialty items, consumers will even pay more for them than for gourmet national brands. Companies that do serious planning when creating a price strategy usually select from three basic approaches: price skimming, penetration pricing, and status quo pricing.
Establish Pricing Goals
The first step in setting the right price is to establish pricing goals. Recall that pricing objectives fall into three categories: profit oriented, sales oriented, and status quo. These goals are derived from the firm's overall objectives. A good understanding of the marketplace and of the consumer can sometimes tell a manager very quickly whether a goal is realistic. All pricing objectives have trade-offs that managers must weigh. A profit maximization objective may require a bigger initial investment than the firm can commit to or wants to commit to. Reaching the desired market share often means sacrificing short-term profit because without careful management, long-term profit goals may not be met. Meeting the competition is the easiest pricing goal to implement. But can managers really afford to ignore demand and costs, the life cycle stage, and other considerations? When creating pricing objectives, managers must consider these trade-offs in light of the target customer, the environment, and the company's overall objectives.
Price Lining
When a seller establishes a series of prices for a type of merchandise, it creates a price line. Price lining is the practice of offering a product line with several items at specific price points. Wireless providers use price lining for cell phones that are purchased with a two-year contract. The top tier is usually priced at $299 (the highest the market will pay), and subsequent tiers are $249, $199, $149, $99, and $49. Price lining reduces confusion for both the salesperson and the consumer. The buyer may be offered a wider variety of merchandise at each established price. Price lines may also enable a seller to reach several market segments. For buyers, the question of price may be quite simple: all they have to do is find a suitable product at the predetermined price. Moreover, price lining is a valuable tactic for the marketing manager, because the firm may be able to carry a smaller total inventory than it could without price lines. The results may include fewer markdowns, simplified purchasing, and lower inventory carrying charges. Price lines also present drawbacks, especially if costs are continually rising. Sellers can offset rising costs in three ways. First, they can begin stocking lower-quality merchandise at each price point. Second, sellers can change the prices, although frequent price line changes confuse buyers. Third, sellers can accept lower profit margins and hold quality and prices constant. This third alternative has short-run benefits, but its long-run handicaps may drive sellers out of business.
Value-Based Pricing
also called value pricing, is a pricing strategy that has grown out of the quality movement. Value-based pricing starts with the customer, considers the competition and associated costs, and then determines the appropriate price. The basic assumption is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers. Because very few firms operate in a pure monopoly, however, a marketer using value-based pricing must also determine the value of competitive offerings to customers. Customers determine the value of a product (not just its price) relative to the value of alternatives. In value-based pricing, therefore, the price of the product is set at a level that seems to the customer to be a good price compared with the prices of other options. Research has found that loyal customers become even more loyal when they receive discounts. Also, customers who are loyal because of superior service and quality are less likely to bargain over price.*
Quantity discounts
are offered when a customer buys multiple units or above a specified dollar amount. A cumulative quantity discount is applied to a buyer's total purchases made during a specific period whereas a noncumulative quantity discount is applied to a single order placed during a certain period.
Promotional allowances (trade allowances)
are payments to dealers for promoting the manufacturer's products.
Leader Pricing
is an attempt by the marketing manager to attract customers by selling a product near or even below cost in the hope that shoppers will buy other items once they are in the store. This type of pricing appears weekly in the newspaper advertising of supermarkets. Leader pricing is normally used on well-known items that consumers can easily recognize as bargains. Leader pricing is not limited to products. Health clubs offer a one-month free trial as a loss leader.
Penetration Pricing
is at the opposite end of the spectrum from skimming. Penetration pricing means charging a relatively low price for a product when it is first rolled out as a way to reach the mass market. The low price is designed to capture a large share of a substantial market, resulting in lower production costs. If a marketing manager has made obtaining a large market share the firm's pricing objective, penetration pricing is a logical choice. Penetration pricing does mean lower profit per unit, however. Therefore, to reach the break-even point, it requires a higher volume of sales than would a skimming policy. The recovery of product development costs may be slow. As you might expect, penetration pricing tends to discourage competition. A penetration strategy tends to be effective in a price-sensitive market. Price should decline more rapidly when demand is elastic because the market can be expanded through a lower price. The ultra-low-cost airline Spirit is now among the most profitable U.S. airlines. Its cut-rate fares include little more than a seat—nearly everything else is sold à la carte. The only complimentary item in the cabin is ice. If you want water with your ice, it costs $3.00. Yet this airline maintains the highest load numbers in the industry and it continues its rapid growth. Clearly, price matters.* If a firm has a low fixed cost structure and each sale provides a large contribution to those fixed costs, penetration pricing can boost sales and provide large increases in profits—but only if the market size grows or if competitors choose not to respond. Low prices can attract additional buyers to the market. The increased sales can justify production expansion or the adoption of new technologies, both of which can reduce costs. And, if firms have excess capacity, even low-priced business can provide incremental dollars toward fixed costs. Penetration pricing can also be effective if an experience curve will cause costs per unit to drop significantly. The experience curve proposes that per-unit costs will go down as a firm's production experience increases. Manufacturers that fail to take advantage of these effects will find themselves at a competitive cost disadvantage relative to others that are further along the curve. The big advantage of penetration pricing is that it typically discourages or blocks competition from entering a market. The disadvantage is that penetration means gearing up for mass production to sell a large volume at a low price. If the volume fails to materialize, the company will face huge losses from building or converting a factory to produce the failed product.
Price Building
is marketing two or more products in a single package for a special price. For example, Microsoft offers "suites" of software that bundle spreadsheets, word processing, graphics, e-mail, Internet access, and groupware for networks of microcomputers. Price bundling can stimulate demand for the bundled items if the target market perceives the price as a good value. Services like hotels and airlines sell a perishable commodity (hotel rooms and airline seats) with relatively fixed costs. Bundling can be an important income stream for these businesses because the variable costs tend to be low—for instance, the cost of cleaning a hotel room. To account for this variability, hotels sometimes charge a resort fee that covers things like use of the gym, pool, and Wi-Fi. Bundling is also widely used in the telecommunications industry. Companies offer local service, long distance, DSL Internet service, wireless, and even cable television in various bundled configurations. Telecom companies use bundling as a way to protect their market share and fight off competition by locking customers into a group of services. For consumers, comparison shopping may be difficult since they may not be able to determine how much they are really paying for each component of the bundle. You inevitably encounter bundling when you go to a fast food restaurant. McDonald's Happy Meals and Value Meals are bundles, and customers can trade up these bundles by super sizing them. Super sizing provides a greater value to the customer and creates more profits for the fast food chain.
Price Skimming
is sometimes called a "market-plus" approach to pricing because it denotes a high price relative to the prices of competing products. The term price skimming is derived from the phrase "skimming the cream off the top." Companies often use this strategy for new products when the product is perceived by the target market as having unique advantages. Often companies will use skimming and then lower prices over time. This is called "sliding down the demand curve." Manufacturers sometimes maintain skimming prices throughout a product's life cycle. A manager of the factory that produces Chanel purses (retailing for over $2,000 each) told one of your authors that it takes back unsold inventory and destroys it rather than selling it at a discount. Price skimming works best when there is strong demand for a good or service. Apple, for example, uses skimming when it brings out a new iPhone or Watch. As new models are unveiled, prices on older versions are normally lowered. Firms can also effectively use price skimming when a product is well protected legally, when it represents a technological breakthrough, or when it has in some other way blocked the entry of competitors. Managers may follow a skimming strategy when production cannot be expanded rapidly because of technological difficulties, shortages, or constraints imposed by the skill and time required to produce a product (such as fine china, for example). A successful skimming strategy enables management to recover its product development costs quickly. Even if the market perceives an introductory price as too high, managers can lower the price. Firms often believe it is better to test the market at a high price and then lower the price if sales are too slow. Successful skimming strategies are not limited to products. Well-known athletes, lawyers, and celebrity hairstylists are experts at price skimming. Naturally, a skimming strategy will encourage competitors to enter the market.
Sales-Oriented Pricing Objectives
maintaining or increasing market share Sales maximization EX: Online Target vs. Walmart vs. JC Penney Shop for some kind of electronic device (such as a Blu-ray player, digital camera, or MP3 player) on the Target, Walmart, and JCPenney websites. Compare the prices of the same device on the three websites. Do they all even carry the same product? Compare the price on the Web with the price offered at the physical store and explain the discrepancies, if any.
Two-Part Pricing
means establishing two separate charges to consume a single good or service. Consumers sometimes prefer two-part pricing because they are uncertain about the number and the types of activities they might use at places like an amusement park. Also, the people who use a service most often pay a higher total price. Two-part pricing can increase a seller's revenue by attracting consumers who would not pay a high fee even for unlimited use. For example, a health club might be able to sell only 100 memberships at $700 annually with unlimited use of facilities, for a total revenue of $70,000. However, it could sell 900 memberships at $200 with a guarantee of using the racquetball courts ten times a month. Every use over ten would require the member to pay a $5 fee. Thus, membership revenue would provide a base of $180,000, with some additional usage fees throughout the year.
Odd-Even Pricing
means pricing at odd-numbered prices to connote a bargain and pricing at even-numbered prices to imply quality. For years, many retailers have priced their products in odd numbers—for example, $99.95—to make consumers feel they are paying a lower price for the product. Even-numbered pricing is often used for "prestige" items, such as a fine perfume at $100 a bottle or a good watch at $1,000. The demand curve for such items would also be sawtoothed, except that the outside edges would represent even-numbered prices and, therefore, elastic demand.
Flexible Pricing
means that different customers pay different prices for essentially the same merchandise bought in equal quantities. This tactic is often found in the sale of shopping goods, specialty merchandise, and most industrial goods except supply items. Car dealers and many appliance retailers commonly follow the practice. It allows the seller to adjust for competition by meeting another seller's price. Thus, a marketing manager with a status quo pricing objective might readily adopt the tactic. Flexible pricing also enables the seller to close a sale with price-conscious consumers. The obvious disadvantages of flexible pricing are the lack of consistent profit margins, the potential ill will of high-paying purchasers, the tendency for salespeople to automatically lower the price to make a sale, and the possibility of a price war among sellers.