Chapter 8 Pricing Strategy and Management. 8-2 In this chapter, you will learn about… 1.Pricing...

Chapter 8

Pricing Strategy

and Management

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In this chapter, you will learn about…

1. Pricing Considerations

Price as an Indicator of Value

Price Elasticity of Demand

Product-Line Pricing

Estimating the Profit Impact from Price

Changes

2. Pricing Strategies

Full-Cost Pricing

Variable-Cost Pricing

New-Offering Pricing Strategies

Pricing and Competitive Interaction


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Price is a direct determinant of profits (or

losses)

Price indirectly affects costs (through

quantity sold)

Price determines the type of customer and

competition the organization will attract

Price affects the image of the brand

A pricing error can nullify all other

marketing mix activities

The Importance of Price


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Profit = Total Revenue – Total Cost

Relationship between Price and Profits

Total Revenue = Price per Unit x Quantity Sold

Total Cost = Fixed Cost + Variable Cost


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Pricing Considerations

Examples of Pricing Objectives:

Maximization of profits

Enhancing product or brand image

Providing customer value

Obtaining an adequate return on investment or cash flow

Maintaining price stability

Pricing Objectives have to be consistent with an organization’s overall marketing objectives


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Pricing Considerations

Demand sets the price ceiling

Direct (variable) costs set the price floor

Campbell Soup’s Intelligent Quisine (IQ) line

Consumers found the products too expensive

Lower price could not cover variable costs


Pricing ConsiderationsConceptual Orientation to Pricing

Source: Kent B. Monroe, Pricing: Making Profitable Decisions, 3rd ed. (Burr Ridge, IL; McGraw Hill/Irwin, 2003).

Final Pricing Discretion

Demand Factors (Value to Buyers)

Initial Pricing Discretion

Competitive Factors

Corporate objectives and regulatory constraints

(Price Ceiling)

(Price Floor)

Direct Variable Costs)

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Pricing ConsiderationsFactors narrowing pricing

discretion

Government regulations

Price of competitive offerings

Organizational objectives and

policies


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Life-cycle stage of product or service

Effect of pricing decisions on profit margins

of marketing channel members

Prices of other products and services

provided by the organization

Pricing ConsiderationsOther factors affecting the pricing

decision


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Value = perceived benefits

price

Value can be defined as the ratio of perceived benefits to price:

Pricing ConsiderationsPrice as an Indicator of Value


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Price affects perception of quality

Price affects consumer perceptions of prestige

Example:

Swiss watchmaker TAG Heuer

Raised average price of its watches from

$250 to $1000

Sales volume increased sevenfold!



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Consumer value assessments are often

comparative – worth and desirability of a

product relative to substitutes that satisfy the

same need (e.g., Equal vs. sugar)

Consumer’s comparison of costs and benefits

of substitute items gives rise to a “reference

value”


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E = percentage change in quantity demanded

percentage change in price

Pricing ConsiderationsPrice Elasticity of Demand

Price Elasticity of Demand is a concept used to

characterize the nature of the price-quantity

relationship

The coefficient of price elasticity, E, is a

measure of the relative responsiveness of the

quantity of a product demanded to a change in

the price of that product


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If the percentage change in quantity

demanded is greater than the

percentage change in price, i.e., E>1,

then demand is said to be elastic.

If the percentage change in quantity

demanded is less than the percentage

change in price, i.e., E<1, then demand

is said to be inelastic.

Pricing ConsiderationsPrice Elasticity of Demand


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The more substitutes the product or service has, the greater the elasticity

The more uses a product or service has, the greater the elasticity

The higher the ratio of the price of the product or service to the income of the buyer, the greater the elasticity

Pricing ConsiderationsFactors affecting Elasticity of

Demand


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Pricing ConsiderationsProduct-Line Pricing

Cross-Elasticity of Demand relates the price elasticity simultaneously to more than one product or service

The Cross-Elasticity Coefficient is the ratio of the change in quantity demanded of product A to a price change in product B

A negative coefficient indicates the products are complementary (camera and film); a positive coefficient indicates they are substitutes (apple and pear)


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1. the lowest-priced product and priceplays the role of traffic builder

2. the highest-priced product and pricepositioned as the premium item

3. price differentials for all other products in the line

reflect differences in their perceived value of the products offered

Product-line pricing involves determining:

Pricing ConsiderationsProduct-Line Pricing


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Cost data

Price data

Volume data for individual

products and services

Impact of price changes on profit can be determined from:

Pricing ConsiderationsEstimating the Profit Impact from

Price Changes


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Price Changes

Unit volume necessary to break even on a price change is:

% change in unit volume to break even on a price change

- (percentage price change)

(original contribution margin) + (percentage price change)

=


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Price Changes

For example, if a product has a 20% contribution

margin, a 5% price decrease will require a 33%

increase in unit volume to break even:

+ 33- (-5)

(20) + (-5)=


Estimating the Profit Impact from Price Changes

Product Alpha Product Beta

Cost, Volume, and Profit Data

Unit sales volume 1,000 1,000

Unit selling price $ 10 $ 10

Unit variable cost $ 7 $ 2

Unit contribution (margin) $ 3 (30%) $ 8 (80%)

Fixed costs $1,000 $6,000

Net profit $2,000 $2,000

Break-Even Sales Change

For a 5% price reduction +20.0% +6.7%



For a 5% price increase -14.3% -5.9%



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Pricing Strategies

Full-cost Price Strategies

Considers both (direct) variable

and (indirect) fixed costs

Full-cost Price Strategies

Considers both (direct) variable

and (indirect) fixed costs

Variable-cost Price Strategies

Considers only (direct)

variable costs

Variable-cost Price Strategies

Considers only (direct)

variable costs


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Pricing StrategiesFull-Cost Pricing

Full-Cost Pricing

Mark-up Pricing

Rate-of-Return Pricing

Break-even Pricing


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Selling price is determined by adding a fixed amount, usually a percentage, to the (total) cost of the product

Most commonly used pricing method (e.g., groceries and clothing)

Simple, flexible, controllable

Example: If a product costs $4.60 to produce and selling price is $6.35, the market on cost is 38% and markup on price is 28%.

Pricing StrategiesMarkup Pricing


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Equals the per-unit fixed costs plus the per-

unit variable costs

Useful tool for determining the minimum

price at which a product must be sold to

cover fixed and variable costs

Often used by non-profit organizations, or by

profit-making organizations that may have a

short-term breakeven objective

Pricing StrategiesBreakeven Pricing


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Price is set so as to obtain a pre-specified

rate of return on investment (capital) for the

organization

Assumes a linear demand function and

insensitivity of buyers to price

Most commonly used by large firms and

public utilities whose return rates are closely

watched or regulated by government

agencies or commissions

Pricing StrategiesRate-of-Return Pricing


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Pricing StrategiesRate-of-Return Pricing

ROI = Pr / I =revenues - cost

investment

P x Q – C x Q

I=

where P = Unit Selling Price; C = Unit Cost;

Q = Quantity Sold

Solving for P, we get:

P =ROI x I x CQ

Q


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Pricing StrategiesRate-of-Return Pricing Example

An organization desires an ROI of 15% on an

investment of $80,000. Total costs per unit are

estimated to be $0.175. Forecasted demand is

20,000 units. The necessary price to attain

15% ROI is:

P =(0.15) x $80,000 + $0.175 x 20,000

20,000= 0.775


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Stimulate demand (lower fares for seniors)

Can increase revenues, and hence, lead to economies of scale, lower unit costs, and higher profits

Shift demand (weeknight calling plans)

Away from peak load times to smooth it out over extended time periods

Represents the minimum selling price at which the product or service can be marketed in the short run. It is often used to:

Pricing StrategiesVariable-Cost Pricing


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Pricing StrategiesNew-Offering Pricing Strategies

1. Skimming Pricing Strategy (Gillette Mach3)

price initially set very high and reduced over time

2. Penetration Pricing Strategy (Nintendo)

price is initially set low to gain a foothold in the market

3. Intermediate Pricing Strategy

between the two extremes; most prevalent


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1. Demand is likely to be price inelastic

2. There are different price-market segments

3. The offering is unique enough to be protected from competition by patent, copyright, or trade secret

4. Production or marketing costs are unknown

5. A capacity constraint in producing the product or providing the service exists

6. An organization wants to generate funds quickly

7. There is a realistic perceived value in the product or service

Pricing StrategiesWhen to Use Skimming Pricing

Appropriate when:


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1. Demand is likely to be price elastic

2. The offering is not unique or protected by patents, copyrights, or trade secrets

3. Competitors are expected to enter market quickly

4. There are no distinct and separate price-market segments

5. There is a possibility of large savings in production and marketing costs if a large sales volume can be generated

6. The organization’s major objective is to obtain a large market share

Pricing StrategiesWhen to Use Penetration Pricing

Appropriate when:


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Competitive Interaction refers to the

sequential action and reaction of rival

companies in setting and changing

prices for their offering(s) and

assessing likely outcomes, such as

sales, unit volume, and profit for each

company and an entire market.

Pricing StrategiesPricing and Competitive Interaction


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1. Managers are advised to focus less on

short-term outcomes and attend more to

longer-term consequences of actions

2. Managers are advised to step into the shoes

of rival managers or companies and answer

a number of questions…


Advice for managers to avoid nearsightedness

of not looking beyond the initial pricing decision:


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1. What are competitors’ goals and objectives? How are they different from our goals and objectives?

2. What assumptions has the competitor made about itself, our company and offerings, and the marketplace? Are these assumptions different from ours?

3. What strengths does the competitor believe it has and what are its weaknesses? What might the competitor believe our strengths and weaknesses to be?



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A Price War involves successive price cutting

by competitors to increase or maintain their unit

sales or market share. Happens when:

Managers lower price to improve market

share, unit sales, and profit

Competitors match the lower price

Expected share, sales, and profit gain from

initial price cut are lost


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1. The company has a cost or technological

advantage over its competitors

2. Primary demand for a product class will

grow if prices are lowered

3. The price cut is confined to specific

products or customers and not across-

the-board

To avoid a price war, managers should consider price cutting only when:




FewManyNumber of competitors

HighLowIndustry capacity utilization

StableDecliningOverall industry cost trend

LowHighBuyer price sensitivity

LowHighPrice visibility to competitors

IncreasingStable/DecreasingMarket growth rate

DifferentiatedUndifferentiatedProduct/Service type

LowerHigherIndustry Characteristics

Risk Level

Industry Characteristics and the Risk of Price Wars

Chapter 8 Pricing Strategy and Management. 8-2 In this chapter, you will learn about… 1.Pricing...

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