Pricing Making Profitable Decisions Third Edition Kent B. Monroe University of Illinois at Urbana Champaign Champaign, Illinois, U.S.A. Chapter 1 Effective Pricing Management McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Russian Proverb • There are two fools in any market: – One does not charge enough. – The other charges too much. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Role of Price Prices determine what products and services should be produced and in what amounts. Prices determine how these products and services should be produced. Prices determine for whom the products and services should be produced. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Definition of Price quantity of money or goods and services Price = received by the seller quantity of goods and services paid by the buyer Pricing Terms Rate Admission Fees User fees Premiums Minimum required balances Rent Interest charges Tuition Tariffs Fares Duties Tolls McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Ways to Change Price Change the quantity of money or goods and services to be paid by the buyer Change the quantity of goods and services to be provided by the seller Change the quality of goods and services provided McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. More Ways to Change Price Change the premiums or discounts to be applied for quantity reasons. Change the time and place of transfer of ownership. Change the place and time of payment. Change the acceptable form of payment. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Faster Technological Progress Has… • Reduced the gap between invention and innovation • Reduced the average age of products • Intensified competition from alternative uses of income McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Proliferation of New Products “Population explosion” of new products Product lines have widened Blurred market segments Small price differentials may produce relatively large shifts in demand McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Increased Demand for Services • Increase in demand for services has led to an increase in prices, which have led to public concern and governmental activity • There is also an increase in demand for services built into products McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Increased Global Competition • Increased foreign trade around the world has increased the amount of price competition faced by domestic producers McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Changing Legal Environment • Deregulation and privatization of companies have resulted in more complex, more difficult, and more important pricing decisions McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Economic Uncertainty • Slowed or stopped inflation rates in other countries’ economies has led to the need for new approaches to developing pricing strategies McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Five Factors to Consider • • • • • Demand Costs Competitive factors Corporate profit and market objectives Regulatory constraints McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Demand Implications • • • • Market versus product elasticity Derived demand for buyer’s output Likelihood of competitive entry Demand consequences of a product line McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Cost Implications • Cost-plus pricing • Maximizing margins • Pricing with scarce resources McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Marketing and Distribution Strategy Implications • The product life cycle • Sales force management McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. How To Become a Proactive Pricer • 1. Understand how pricing works • 2. Understand how customers perceive prices and price changes McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Three Levels of Pricing Management • 1. Understanding the economic and competitive environment – Factors that influence supply and demand • 2. Developing product and market pricing strategy – Benefits, costs, and prices • 3. Administering the pricing process – Tactical pricing decisions McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Level One • 1. Traditional Economic • How will current and future supply and demand dynamics affect overall market price levels? – – – – McGraw-Hill/Irwin Economic/market environment Changes in competition, supply, capacity Shifts in demand New product developments © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Level Two • 2. Product and Market Strategy • Within each market segment, what is the correct list or target price for each product? – – – – Customers’ perceptions of price and value Price research Profitability analysis Pricing strategy McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Concept Of Benefits • A product or service must promise to: – Perform identified functions, – Solve identified problems, or – Provide specified pleasure. • Thus, a product or service is bought for what it does, not what it is made of. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Customer’s Perceptions Are Important! • The relative benefits customers perceive the product or service provides; • The relative total costs of acquiring, installing, and using the product or service over its lifetime; • The tradeoff that customers perceive between receiving the perceived benefits compared to the total costs - perceived value McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Model Of Price-value Relationship Perceived quality Actual Price Perceived value Willingness to buy Perceived monetary sacrifice McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Level Three • 3. Price Structure Management • How to determine the actual price to receive from each transaction? – Organizing for price administration – Transaction management: setting discounts, allowances, rebates… – Establishing pricing tactics – Maintaining feedback and control – Legal and ethical issues McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Tactical Pricing Decisions • Tactical pricing decisions concern day-to-day management of the pricing function, including: – – – – – Timing of price changes Amount of price changes Direction of price changes Administering price changes Communicating price changes to • sales force • customers McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Topics Covered in Following Sections! • Section 1: Economic and competitive issues • Section 2-3: Techniques to acquire and analyze relevant information • Section 4: How to develop prices for product life cycles and multiple products/services • Section 5: How to increase pricing flexibility • Section 6: Techniques for pricing in a competitive bidding situation • Section 7: Guidelines for developing and implementing a proactive approach to pricing McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.