CHAPTER FIFTEEN
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PRICING CONCEPTS
Prepared by Jack Gifford
Miami University (Ohio)
© 2001 South-Western College
Publishing
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IMPORTANCE OF PRICING
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$ To the consumer…
$ The cost of something
$ To the marketer…
$ Price is revenue, source of
profit
$ In the broadest sense, price
allocates resources in a freemarket economy
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WHAT IS A PRICE?
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$ Is that which is given up in
$
$
$
$
an exchange to acquire a
good or service
Can relate to anything with
perceived value
Facilitates the exchange
process
Is the medium of exchange
An agreed upon
abstraction based upon
supply and demand and
value assessment
$ Has many names:
$
$
$
$
$
$
$
Revenue
Rent
Fee
Donation
Toll
Honorarium
Tuition
© 2001 South-Western College
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IMPORTANCE OF PRICE TO MARKETING
MANAGERS
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$ Revenue is the price charged to
customers multiplied by the number of
units sold
$ Revenue is what pays for every activity
of a company
$ Profit is what’s left over after paying for
all these activities
$ Marketers must select a price that is
not too high or not too low, a price that
equals the perceived value to target
consumers
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PRICING OBJECTIVES
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1. PROFIT MAXIMIZATION
$ Profit-oriented pricing
objectives
$ Sales-oriented pricing
objectives
$ Status quo pricing
objectives
•Setting prices so that total
revenue is as large as
possible relative to total
costs
•Competitive
environment?
•Highest price possible
given consumers perceived
value of the product
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PRICING OBJECTIVES
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$ Profit-oriented pricing
objectives
$ Sales-oriented pricing
objectives
$ Status quo pricing
objectives
2. SATISFACTORY
PROFITS
•Setting prices so that
profits to stakeholders are
satisfactory
•What is satisfactory
depends upon levels of risk
and management
objectives
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PRICING OBJECTIVES
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$ Profit-oriented pricing
objectives
$ Sales-oriented pricing
objectives
$ Status quo pricing
objectives
3. TARGET RETURN ON
INVESTMENT (ROI)
•ROI = NPat / TA
•If you think of your
savings account, it is the
interest you earn on your
money; the more the better
•A “good” ROI depends
upon the level of risk,
industry benchmarks, and
available alternatives
© 2001 South-Western College
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PRICING OBJECTIVES
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$ Profit-oriented pricing
1. Market share: A percentage
of sales for that industry
A Sales can be reported in
either dollars or units
objectives
$ Sales-oriented pricing
objectives
$ Status quo pricing
B Profitability and high
market share are often
highly correlated..but not
always
2. Sales Maximization
objectives
© 2001 South-Western College
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PRICING OBJECTIVES
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$ Profit-oriented pricing
objectives
$ Sales-oriented pricing
objectives
$ Status quo pricing
objectives
1. Seeks to maintain existing
prices or meet the
competition’s prices
A Price leadership
B Minimizes price wars
© 2001 South-Western College
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PRICE IN THE ECONOMY
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$ The Demand Curve:
$ Demand is the quantity of a
Price
product consumers are willing
and able to buy at a given
price. Normally, the higher the
price, the lower the demand.
$ As prices drop, consumers will 2$
be willing to purchase more of
an item
1$
$ The slope of the demand line
depends upon the sensitivity
of demand to prices
Demand
Quantity
One
unit
© 2001 South-Western College
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Two
units
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ELASTICITY OF DEMAND
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$ Price elasticity
measures the
percentage change in
quantity demanded by
a percentage change
in price.
$ Elastic
$ Inelastic
$ Unitary elasticity
E=
% CHANGE IN QUANTITY
DEMANDED OF GOOD “A”
% CHANGE IN PRICE OF
GOOD “A”
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ELASTICITY OF DEMAND: INELASTIC
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$ Relatively
Price
Inelastic
Demand
A relatively large increase in
price results in only a small
decrease in quantity
demanded.
Quantity
E is less than 1.0
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ELASTICITY OF DEMAND: ELASTIC
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$ Relatively
Price
Elastic
Demand
A relatively small decrease
in price results in a
substantial increase in
quantity demanded.
Quantity
E is greater than 1.0
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FACTORS THAT AFFECT ELASTICITY
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$ Availability of substitutes
$ Price relative to purchasing power
$ Product durability
$ A product’s other uses
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THE COST DETERMINANT OF PRICE
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$ All costs are Fixed, Variable,
or a combination of fixed and
variable
$ The costs and revenues
associated with the
production of “one more
unit” of a product are called
marginal costs and marginal
revenues
$ An analysis of these and
other costs help marketers
determine alternative pricing
strategies
© 2001 South-Western College
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ALTERNATIVE METHODS OF COST
BASED PRICING
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$ Markup pricing
$ Formula pricing (keystoning)
$ Profit maximization pricing
$ Break-even pricing
$ Target-return pricing
© 2001 South-Western College
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OTHER DETERMINANTS OF PRICE
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1 Stage in the product life cycle
$ Introductory
$ Growth
$ Maturity
$ Decline
$ High or low pricing
$ Prices begin to stabilize
and drop
$ Prices drop dramatically
$ Lowest prices; little if
any profits; prices may
be below costs
© 2001 South-Western College
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OTHER DETERMINANTS OF PRICE
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1 The competition
2 Distribution strategy
3 Promotion strategy
4 The relationship of price to quality
5 Demands of larger customers
6 Global environmental influences
© 2001 South-Western College
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HOW TO SET A PRICE ON A PRODUCT
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$ Setting the right price on a product is a
four-step process:
$ Establish pricing goals
$ Estimate demand, costs, and profits
$ Choose a price strategy to help determine a base price
$ Fine tune the base price with pricing tactics
© 2001 South-Western College
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SETTING A PRICE ON A PRODUCT:
Establishing pricing goals
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$ Select profit-oriented, sales-oriented, or
status quo, as discussed in the prior
chapter
$ Must study the competition to determine
reasonableness of pricing goals
$ Determine market share necessary to achieve desired
pricing goals
$ All pricing goals have trade-offs
© 2001 South-Western College
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SETTING A PRICE ON A PRODUCT:
Estimate demand, costs, and profits
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$ Revenue is a function of price and quantity
demanded
$ Quantity demanded depends upon elasticity
$ Therefore, marketers must estimate the profit
that can be generated at various prices, given
demand, elasticity and costs.
$1.35 ?
$1.49 ?
© 2001 South-Western College
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SETTING A PRICE ON A PRODUCT:
Choose a price strategy
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$ The basic, long-term pricing framework for
a good or service should be a logical
extension of the pricing objectives.
$ Must determine initial price and price
points over time as the product moves
through the product life cycle
$ Must be set to provide a perceived value
for a defined target market
© 2001 South-Western College
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SETTING A PRICE ON A PRODUCT:
Choose a price strategy
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$ Price higher than those of
$ Three basic strategies
$
include…
$ Price skimming
$
$ Penetration pricing
$
$ Status quo pricing
$
competitors
Used when a product or
service has a unique
advantage
Used when demand exceeds
supply in the short run
May take advantage of legal
protection against competition
(patents)
To create a prestige image
© 2001 South-Western College
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SETTING A PRICE ON A PRODUCT:
Choose a price strategy
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$ The basic, long-term pricing framework for
a good or service should be a logical
extension of the pricing objectives.
$ Must determine initial price and price
points over time as the product moves
through the product life cycle
$ Must be set to provide a perceived value
for a defined target market
© 2001 South-Western College
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SETTING A PRICE ON A PRODUCT:
Choose a price strategy
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$ Set price lower than
$ Three basic strategies
$
include…
$
$ Price skimming
$ Penetration pricing
$ Status quo pricing
$
$
competition
A means to reach the mass
market
Designed to capture a large
market share
Lower prices usually mean
higher break-even-points
Effective in a price-sensitive
market
Southwest
Airlines strategy
© 2001 South-Western College
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THE LEGALITY AND ETHICS OF PRICE
STRATEGY
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$ Some price decisions
are subject to
government
regulation designed to
stimulate full
disclosure, prevent
monopolies, and
stimulate the free
market enterprise
system
© 2001 South-Western College
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THE LEGALITY AND ETHICS OF PRICE
STRATEGY
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$ Unfair Trade Practices
© 2001 South-Western College
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Retailer
Cost
Selling price
Wholesaler
states in the USA
$ Selling below cost is
illegal
$ Wholesalers and retailers
must have a minimum
markup of ….. (depends
upon state)
$ Designed to protect small
competitors
40
35
30
25
20
15
10
5
0
Manufacturer
$ Exist in about 1/2 of the
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THE LEGALITY AND ETHICS OF PRICE
STRATEGY
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$ Price fixing
$ An agreement between
two or more firms on the
price they will charge for a
product or service.
$ Illegal under the Sherman
Act and the Federal Trade
Commission Act
$ Can result in both fines
and jail sentences!
If we both charge $40 per dozen
units and share the market 50/50,
we will both come out ahead.
© 2001 South-Western College
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THE LEGALITY AND ETHICS OF PRICE
STRATEGY
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$ Price discrimination
$ Sellers must offer
substantially identical
goods to different parties
for the same price and
terms if the situations are
materially the same
$ Only relates to interstate
trade
$ Must be carried out in a
short period of time
$ Products must be of like
grade and and quality
$ The charging of different
prices must result in a
significant competitive
injury
$ COMMON DEFENSES BY
SELLERS INCLUDE...
© 2001 South-Western College
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THE LEGALITY AND ETHICS OF PRICE
STRATEGY
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$ A seller MAY charge
different prices even in the
above named situations
IF…
$ The price differential is justified
by different manufacturing costs
or quantity discount savings
$ In good faith to meet changing
market conditions
$ To meet the prices of competition
These exceptions
provide lots of “weasel
room” for marketers!
© 2001 South-Western College
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THE LEGALITY AND ETHICS OF PRICE
STRATEGY
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$ Predatory pricing
$ Is the practice of charging
a very low price for a
product with the INTENT
of driving competitors out
of business or out of a
market
$ Illegal under the Federal
Trade Commission Act
$ Must prove both intent
and sale below average
cost to prosecute
© 2001 South-Western College
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TACTICS FOR FINE TUNING THE BASE
PRICE
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$ Discounts, Allowances, Rebates and Value
Pricing
$
$
$
$
$
$
$
Quantity discounts
Cash discounts
Functional discounts
Seasonal discounts
Promotional discounts
Rebates
Value based pricing (trade loading)
© 2001 South-Western College
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Price = X
-QD
-CD
-FD
------------Net price
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TACTICS FOR FINE TUNING THE BASE
PRICE
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$ Geographic pricing
$ FOB, origin pricing
$ Uniform delivered pricing
$ Zone pricing
$ Freight absorption pricing
$ Basing-point pricing
© 2001 South-Western College
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TACTICS FOR FINE TUNING THE BASE
PRICE
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$ Special pricing tactics
$ Single-price tactic
$ Flexible or variable pricing
$
$
$
$
$
$
(cars)
Professional services pricing
Price lining
Leader or loss leader pricing
Odd-even pricing
Price bundling
Two-part pricing
© 2001 South-Western College
Publishing
For you
the price
is $19.95
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