Chapter 16: Pricing Concepts
Prepared by David Ferrell, B-books, Ltd.
Designed by Eric Brengle, B-books, Ltd.
Copyright 2012 by Cengage Learning Inc. All Rights Reserved
1
Learning Outcomes
LO1
Discuss the importance of pricing decisions
to the economy and to the individual firm
LO2
List and explain a variety of pricing objectives
LO3
Explain the role of demand in price
determination
LO4
Understand the concept of yield management
systems
LO5
Describe cost-oriented pricing strategies
Copyright 2012 by Cengage Learning Inc. All Rights Reserved
2
Learning Outcomes
LO6
Demonstrate how the product life cycle,
competition, distribution and promotion
strategies, guaranteed price matching,
customer demands, the Internet, and
perceptions of quality can affect price
LO7
Describe the procedure for setting the right
price
LO8
Identify the legal and ethical constraints on
pricing decisions
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3
The Importance of Price
LO1
Discuss the importance of
pricing decisions to
the economy
and to the individual firm.
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4
The Importance of Price
To the seller...
Price is revenue
To the consumer...
Price is the cost
of something
Price allocates resources
in a free-market economy
5
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What is Price?
Price is that which is given
up in an exchange to acquire
a good or service.
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The Importance of Price to
Marketing Managers
Revenue - The price charged to
customers multiplied by the
number of units sold.
Profit - Revenue minus expenses.
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Trends Influencing Price
Flood of new products
Increased availability of bargain-priced private
and generic brands
Price cutting as a strategy to maintain or
regain market share
Internet used for comparison shopping
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LO1
Review Learning Outcome
The Importance of Pricing Decisions
Price X Sales Unit = Revenue
Revenue – Costs = Profit
Profit drives growth, salary increases, and corporate investment
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Pricing Objectives
LO2
List and explain a variety of
pricing objectives.
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Pricing Objectives
Profit-Oriented
Sales-Oriented
Status Quo
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Profit-Oriented Pricing Objectives
Profit-Oriented Pricing Objectives
Profit
Maximization
Satisfactory
Profits
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Target
Return on
Investment
12
Profit Maximization
Setting prices so that total
revenue is as large as possible
relative to total costs.
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Return on Investment
Net profit after taxes divided by
total assets.
ROI = Net profit after taxes
Total assets
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14
Sales-Oriented Pricing Objectives
Sales-Oriented Pricing Objectives
Market
Share
Sales
Maximization
http://www.target.com
http://www.walmart.com
http://www.jcpenney.com
Online
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Market Share
A company’s product sales
as a percentage of total sales
for that industry.
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Sales Maximization
• Short-term objective to maximize sales
• Ignores profits, competition, and the
marketing environment
• May be used to sell off excess inventory
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Status Quo Pricing Objectives
Status Quo Pricing Objectives
Maintain
existing
prices
Meet
competition’s
prices
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Review Learning Outcome
LO2
Pricing Objectives
Profit-Oriented
Profit
Maximization
Satisfactory
Profits
Target
ROI
Sales-Oriented
Market
Share
Sales
Maximization
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Status Quo
Maintain
Existing Price
19
The Demand Determinant of Price
LO3
Explain the role of demand in
price determination.
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The Demand Determinant of Price
Demand - The quantity of a product
that will be sold in the market at
various prices for a
specified period.
Supply- The quantity of a
product that will be
offered to the market by a supplier
at various prices for a
specified period.
http://www.ubid.com
Online
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21
The Demand Curve
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The Supply Curve
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How Demand and Supply Establish Price
Price equilibrium - The price at
which demand and supply
are equal.
Elasticity of Demand Consumers’ responsiveness or
sensitivity to changes in price.
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Price Equilibrium
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Elasticity of Demand
Elastic
Demand
Inelastic
Demand
Unitary
Elasticity

Consumers buy more or less
of a product when the price
changes.

An increase or decrease in
price will not significantly
affect demand.

An increase in sales exactly
offsets a decrease in prices,
and revenue is unchanged.
26
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Elasticity of Demand
Elasticity (E)
=
Percentage change in quantity
demanded of good A
Percentage change in price of good A
If E is greater than 1, demand is elastic.
If E is less than 1, demand is inelastic.
If E is equal to 1, demand is unitary.
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27
Elasticity of Demand
Price Goes...
Revenue Goes...
Demand is...
Down
Up
Elastic
Down
Down
Inelastic
Up
Up
Inelastic
Up
Down
Elastic
Up or Down
Stays the Same Unitary Elasticity
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Elasticity of Demand
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Factors that Affect Elasticity of
Demand
Availability of substitutes
Price relative to
purchasing power
Product durability
A product’s other uses
Rate of inflation
http://www.columbiahouse.com
Online
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Creating Pricing Power
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LO3
Review Learning Outcome
Role of Demand in Price Determination
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32
The Power of
Yield Management Systems
LO4
Understand the concept of
yield management systems.
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Yield Management Systems
A technique for adjusting prices
that uses complex mathematical
software to profitably fill unused
capacity.
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Yield Management Systems
Discounting early purchases
Limiting early sales at discounted prices
Overbooking capacity
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Yield Management Systems
• Rental property landlords use yield management
systems to raise rents at a faster pace.
• The “M/PF Yield-Star Price Optimizer” is similar
to pricing systems used by airlines and car-rental
companies.
• It uses data such as number of vacancies and
forecasted market conditions to determine the
optimal rent.
• Tenants can also take advantage of the technology.
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LO4
Review Learning Outcome
Yield Management Systems
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The Cost Determinant of Price
LO5
Describe cost-oriented pricing
strategies.
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The Cost Determinant of Price
Types of Costs
Variable
Cost
Fixed Cost
Varies with changes
in level of output
Does not change
as level of output changes
39
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The Cost Determinant of Price
Markup pricing
Methods
Used to
Set Prices
Keystoning
Profit Maximization
Pricing
Break-Even
Pricing
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Markup Pricing
Markup Pricing – The cost of buying the
product from the producer plus
amounts for profit expenses n
ot otherwise accounted for.
Keystoning – The practice of marking
up prices by 100%, or doubling the cost.
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Profit Maximization
Profit Maximization – The method of
setting prices that occurs when
marginal revenue equals marginal cost.
Marginal Revenue – The extra revenue
associated with selling an extra unit of
output, or the change in total revenue with a
one-unit change in output.
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42
Break-Even Pricing
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Break-Even Pricing
Break-Even
Quantity
Fixed cost
Contribution
=
=
Total fixed costs
Fixed cost contribution
Price - Avg. Variable Cost
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LO5
Review Learning Outcome
Cost-Oriented Pricing Strategies
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45
Other Determinants of Price
LO6
Demonstrate how the
product life cycle, competition,
distribution and promotion
strategies, guaranteed price
matching, customer demands,
the Internet, and perceptions of
quality can affect price.
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46
Other Determinants of Price
Stages of the
Product Life Cycle
Competition
Distribution Strategy
Promotion Strategy
Perceived Quality
47
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Stages in the Product Life Cycle
Introductory
Stage
Growth
Stage
Maturity
Stage
Decline
Stage
$
$
$
$
High
Stable
Decrease
Decrease
Stable
High
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48
The Competition
• High prices may induce firms to enter the
market
• Competition can lead to price wars
• Global competition may force firms to
lower prices
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Distribution Strategy
Manufacturers
• Offer a larger profit margin or
trade allowance
Wholesalers/Retailers
 Sell against the brand
 Buy gray-market goods
• Use exclusive distribution
• Franchising
• Avoid business with pricecutting discounters
• Develop brand loyalty
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50
Distribution Strategy
Selling Against the Brand- Stocking
well-known branded items at
high prices in order to sell store
brands at discounted prices.
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The Impact of the Internet
Product selection
Second opinions from expert sites
Shopping bots
Internet auctions
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Promotion Strategy/Price Guarantee
Promotion Strategy
•
Price used as promotional tool
•
Pricing can also be a tool for trade promotions
Price Guarantee
•
Match any competitor’s price
•
Signals to target market it is positioned as a lowprice dealer
53
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The Relationship of Price to Quality
Prestige Pricing - Charging a high
price to help promote a highquality image.
http://www.vivre.com
http://www.ashford.com
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Online
54
Dimensions of Quality
1. Ease of use
2. Versatility
3. Durability
4. Serviceability
5. Performance
6. Prestige
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LO6
Review Learning Outcome
Factors Affecting Price
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How to Set a Price on a
Product or Service
LO7
Describe the procedure for
setting the right price.
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How to Set a Price on a
Product or Service
Establish pricing goals
Estimate demand, costs, and profits
Choose a price strategy
Fine tune with pricing tactics
Results lead to the right price
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58
Establish Pricing Goals
Profit-Oriented
Sales-Oriented
Status Quo
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Choose a Price Strategy
Price Strategy - A basic,
long-term pricing framework,
which establishes the initial
price for a product and the
intended direction for price
movements over the product
life cycle.
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Choose a Price Strategy
Price skimming - A firm charges a high
introductory price, often coupled
with heavy promotion.
Penetration Pricing - A firm charges a
relatively low price for a product initially as a way
to reach the mass market.
Status Quo Pricing - Charging a price
identical to or very close to the competition’s price.
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Price Skimming
Inelastic Demand
Situations
When
Price
Skimming
Is
Successful
Unique Advantages/Superior
Legal Protection of Product
Technological Breakthrough
Blocked Entry to Competitors
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Penetration Pricing
Advantages



Discourages or blocks
competition from
market entry
Boosts sales and
provides large profit
increases
Disadvantages

Requires gear up for
mass production

Selling large volumes
at low prices

Strategy to gain market
share may fail
Can justify production
expansion
http://www.iflyswa.com
Online
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Status Quo Pricing
Advantages

Simplicity

Safest route to
long-term survival
for small firms
Disadvantages

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Strategy may
ignore demand
and/or cost
64
LO7
Review Learning Outcome
Setting the Right Price
Establish
price
goals
High $
Estimate demand,
costs, and profits
Skimming
Choose a
price strategy
Status quo
Penetration
Low $
Evaluate
results
Fine-tune
base price
Set price
$x.yy
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65
The Legality and Ethics of
Price Strategy
LO8
Identify the legal and ethical
constraints on pricing
decisions.
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The Legality and Ethics of
Price Strategy
Unfair Trade Practices
Price Fixing
Price Discrimination
Predatory Pricing
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The Legality and Ethics of Price Strategy
Unfair Trade Practices- Laws
that prohibit wholesalers and
retailers from selling below
cost.
Price Fixing- An agreement
between two or more firms on
the price they will charge for a
product.
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68
Price Discrimination
The Robinson-Patman Act of 1936:
1. There must be price discrimination.
2. Transaction must occur in interstate commerce.
3. Seller must discriminate by price among two or more
purchasers.
4. Products sold must be commodities or tangible goods.
5. Products sold must be of like grade and quality.
6. There must be significant competitive injury.
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69
Price Discrimination
The Robinson-Patman Act of 1936:
Seller Defenses
Cost
Market
Conditions
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Competition
70
Predatory Pricing
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.
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LO8
Review Learning Outcome
The Legality and Ethics of Price Strategy
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72