Chapter 13: Pricing concepts and setting the
right price
Chapter outline
• The importance of price to marketing managers
• Pricing objectives
• The demand determinant of price
• The cost determinant of price
• Other determinants of price
• The relationship between price and quality
• How to set a price on a product
• The role of price in a positioning strategy
The importance of price to marketing managers
• Price: what is given up in an exchange to acquire goods or a
service
• Revenue: the price charged to customers multiplied by the
number of units sold
• Profit: what is left over after all activities have been paid
The importance of price to marketing managers
(continued)
• Prices must represent value to buyers to facilitate exchange
• Prices must not be too low or too high
• Prices can:
• Influence perceptions and positioning
• Be a competitive advantage
Pricing objectives
Profit-orientated pricing objectives
• Profit maximisation
• Satisfactory profits
• Target return on investment
• Net profit after taxes total assets
Sales-oriented pricing objectives
• Market share: firms product sales as % of total industry sales
• Sales maximisation
Status quo pricing objectives
• Maintain existing prices or meet competition’s prices
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
Price (R)
Demand curve
0
Quantity demanded per week
The demand determinant of price (continue)
Economic theory of demand:
• As price increases, demand decreases
• As price decreases, demand increases
The demand determinant of price (continue)
Supply: the quantity of a product that will be offered by a
supplier(s) at various prices for a specified period
Price (R)
0
Supply curve
Quantity supplied per week
The demand determinant of price (continue)
Economic theory of supply:
• As price increases, supply increases
• Because, the higher the price charged, the more goods the
supplier can manufacture
The demand determinant of price (continue)
Equilibrium price: when demand and supply are equal
Supply curve
Price (R)
Demand curve
0
Quantity supplied per week
The demand determinant of price (continue)
• Elasticity of demand: consumers’ responsiveness or sensitivity
to changes in price
• Elastic demand: when consumers buy more or less of a
product when the price changes
• Inelastic demand: an increase or decrease in price will not
significantly affect demand for the product
• Unitary elasticity: an increase in sales exactly offsets a
decrease in prices so that the total revenue remains the same
The demand determinant of price (continue)
Elasticity of demand
% change in quantity demanded
Elasticity =
% change in price
• If E>1, elastic demand
• If E<1, inelastic demand
• If E=1, unity demand
The demand determinant of price (continue)
Example of
elastic demand
Example of
inelastic demand
Price
(R)
Price
(R)
0
0
Quantity
Quantity
The demand determinant of price (continue)
Factors that affect elasticity:
• Availability of substitutes e.g. Telkom and Neotel
• Price relative to purchasing power e.g. salt
• Product durability i.e. repairing durable products instead of
replacing them e.g. cars
• A product’s other uses e.g. medicine
The cost determinant of price
Cost is a multi-faceted concept:
• Variable costs: costs that change with changes in the level of
production e.g. cost of materials
• Fixed costs: costs that do not change as output is increased or
decreased e.g. rent
Total variable cost
• Average variable costs (AVC) =
quantity of output
Total cost
• Average total costs (ATC) =
quantity of output
• Marginal costs (MC) = change in total costs associated with oneunit change in output
The cost determinant of price (continued)
Costs can be used to use prices in a variety of ways:
• Mark-up pricing: cost of buying the product from the producer,
plus amounts for profit and expenses
• Profit maximisation pricing: occurs when marginal revenue
equals marginal cost
• Break-even pricing: what sales volume must be reached before
the firm breaks even
The cost determinant of price (continued)
Break-even analysis:
Total fixed cost
• Break-even quantity =
fixed cost contribution
Limitations:
• Hard to know if cost is fixed/variable
• Ignores demand
Other determinants of price
Stages in the product life cycle
• Introductory: price skimming
• Growth: stabilisation of prices
• Maturity: price decreases as competition increases
• Decline: further price decreases
• The competition
• Distribution strategy
• Marketing communication
• The relationship between price and quality
How to set a price on a product
Formulate pricing objectives
Estimate demand, cost and profits
Choose a price strategy (for base price)
Fine-tune the base with pricing tactics
The result is the ‘right’ price
How to set a price on a product
1. Formulate pricing objectives
• Profit-oriented pricing objectives
• Sales-oriented pricing objectives
• Status quo
How to set a price on a product
2. Estimate demand, cost and profits
• Estimate total revenue at a variety of prices (total revenue is a
function of price and quantity demanded)
• Determine corresponding costs for each price
• Estimate how much profit and market share can be earned at
each possible price
How to set a price on a product
3. Choose a price strategy (for base price)
• Price skimming: high price in relation to competing products
• Penetration pricing: low price to reach the mass market as
soon as possible
• Status quo pricing: charge a price very close to the
competitors’ price
How to set a price on a product
3. Choose a price strategy (for base price)
The legality and ethics of price strategies
• Price fixing: an agreement between two or more firms on the
price they will charge for a product (illegal under Competition
Act)
• Predatory pricing: charging a very low price for a product with
the intention of driving competitors out of business or out of a
market
How to set a price on a product
3. Fine-tune the base with pricing tactics
• Discounts, allowances and rebates
• Trade loading
• Geographic pricing
• Special pricing tactics
How to set a price on a product
3. Fine-tune the base with pricing tactics (continued)
Discounts, allowances and rebates
• Quantity discounts
• cumulative quantity discount
• non-cumulative quantity discount
• Cash discounts
• Functional discounts
• Seasonal discounts
• Promotional allowances
• Rebates
How to set a price on a product
3. Fine-tune the base with pricing tactics (continued)
Trade loading
• Occurs when a manufacturer temporarily lowers the price to
induce wholesalers and retailers to buy more products than
can be sold in a reasonable time
How to set a price on a product
3. Fine-tune the base with pricing tactics (continued)
Geographic pricing
• Free on board (FOB)
• Uniform delivered pricing
• Zone pricing
• Freight absorption pricing
• Basing-point pricing
How to set a price on a product
3. Fine-tune the base with pricing tactics (continued)
Special pricing tactics
• Single-price tactic
• Flexible pricing
• Price lining
• Leader pricing
• Bait pricing
• Odd-even pricing
• Price bundling
• Two-part pricing
• Product-line pricing
Product-line pricing
Product-line pricing: setting prices for an entire line of products;
marketing manager aims to maximise profits for the entire product
line.
Relationships between products in the line:
• Complementary items: increase in sale of one leads to increase in
demand for another
• Substitute products: if buying one item, consumers are less likely to
buy 2nd item in the product line
• Neutral relationship: demand for one product is unrelated to
demand for another
Pricing during difficult economic times
During times of inflation:
• Cost-oriented tactics
• culling products with a low profit margin
• delayed-quotation pricing
• escalator pricing
• Demand-oriented tactics
• price shading
Tactics to make demand more inelastic:
• cultivate selected demand
• create unique offerings
• change the package size
• heighten buyer dependence
Pricing during difficult economic times
(continued)
During times of recession: period of slowing economic activity
Tactics:
• Value pricing
• Price bundling or unbundling
Tactics to use with suppliers:
• Renegotiate contracts with suppliers
• Offer help to suppliers
• Keeping the pressure on
• Paring down suppliers
The role of price in a positioning strategy
• Some brands position themselves based on affordability
• Product is made available at lowest price possible
• Pep stores, Crazy Store
• Other brands position themselves as exclusive with a higher
price
• Jaguar, Versace