Chapter 5 Consumer Behavior

Chapter 18

Pricing Concepts

CHAPTER 18 Pricing Concepts

Chapter Objectives

1.

Outline the legal constraints on pricing.

2.

Identify the major categories of pricing objectives.

3.

Explain price elasticity and its determinants.

4.

List the practical problems involved in applying price theory concepts to actual pricing decisions.

Copyright © 2012 by South Western, a division of Cengage Learning. All rights reserved.


Chapter Objectives

5.

Explain the major cost-plus approaches to price setting.

6.

List the chief advantages and shortcomings of using breakeven analysis in pricing decisions.

7.

Explain the use of yield management in pricing decisions.

8.

Identify the major pricing challenges facing online and international marketers.



Pricing and the Law

o Price is the exchange value of a good or service o Federal, state, and local laws all influence pricing decisions o Tariffs levied on imported goods and services can help firms protect local markets o Countries impose them to protect domestic suppliers



Pricing and the Law

o Government regulation also imposes costs that affect prices o Some companies use regulatory cost recovery as a source of additional revenue



Robinson-Patman Act

o Federal legislation prohibiting price discrimination that is not based on a cost differential; also prohibits selling at an unreasonably low price to eliminate competition o Inspired by price competition triggered by the rise of grocery store chains



Robinson-Patman Act

o Price discrimination - Some consumers pay more than others for the same product o Example: Sending catalogs of identical goods with differing prices targeted by ZIP code o A defense based on cost differentials works only if the price differences do not exceed the cost differences resulting from selling to various classes of buyers



Unfair-Trade Laws

o State laws requiring sellers to maintain minimum prices for comparable merchandise o Intended to protect small specialty stores from lossleader tactics



Fair-Trade Laws

o Statutes enacted in most states that once permitted manufacturers to stipulate a minimum retail price for their product o Assumes a product’s price is part of its image, which the manufacturer owns o These laws were eventually invalidated by the 1975

Consumer Goods Pricing Act





Profitability Objectives

o Consumers must be convinced they are receiving good value for their money o Intense competition results from competition for leadership position o Basic formulas for profit and revenue:



Reading Quiz 11 – Q. 4

o A firm sells 1000 units of shoes for a price of $32 each. Its variable cost is $12 and its total cost is $29.

o What is the firm’s overall revenue?

_________________________ o What profit (loss) does the firm make?

_____________________


Profitability Objectives

o Marginal analysis - Method of analyzing the relationship among costs, sales price, and increased sales volume o Profit maximization - Point at which the additional revenue gained by increasing the price of a product equals the increase in total costs o Target-return objective - Short-run or long-run pricing objectives of achieving a specified return on either sales or investment



Volume Objectives

o Belief that increased sales volume is more important in the long run than immediate profits o Can maximize sales through pricing and nonprice factors such as service and quality o Market-share objective - The goal of controlling a specified minimum share of the market for a firm’s good or service


Sales vs. Profits


500 units x $10.00 = $5000.00

500 units x $8.00 = $4000.00

Profit = $1000.00

600 units x $9.00 = $5400.00

600 units x $8.00 = $4800.00

Profit = $600.00

400 units x $11.00 = $4400.00

400 units x $8.00 = 3200.00

Profit = $1200.00


Meeting Competition Objectives

o Firms sometimes set prices to match established industry price leaders o Shifts marketing mix to focus on nonprice factors



Value Pricing

o Pricing strategy emphasizing benefits derived from a product in comparison to the price and quality levels of competing offerings o Works best for relatively low-priced goods and services o Challenge is convincing customers that low-priced brands offer quality comparable to that of a higherpriced product



Prestige Objectives

o Establishing a relatively high price to develop and maintain an image of quality and exclusiveness that appeals to status-conscious consumers o Example: Tag Heuer watches



Pricing Objectives of Not-for-Profit

Organizations

o Pricing strategy helps them achieve specific goals: o Profit maximization o Cost recovery o Market incentives o Market suppression





Methods for Determining Prices

o Prices are traditionally determined in two basic ways: o Supply and demand o Cost-oriented analyses o Customary prices - Traditional prices that customers expect to pay for certain goods and services



Price Determination in Economic Theory

o Demand - The amounts of a firm’s product that consumers will purchase at different prices during a specified time period o Supply - The amounts of a good or service that will be offered for sale at different prices during a specified period o Pure competition - A market structure with so many buyers and sellers that no single participant can significantly influence price



Price Determination in Economic Theory

o Monopolistic competition - Diverse parties exchange heterogeneous, relatively well- differentiated products, giving marketers some control over prices o Oligopoly - Relatively few sellers; each has large influence on price o Monopoly - Only one seller of a product exists and for which there are no close substitutes



Cost and Revenue Curves

o A product’s total cost is composed of total variable costs and total fixed costs o Variable costs - Change with the level of production o Raw materials and labor costs o Fixed costs - Remain stable at any production level within a certain range o Lease payments or insurance costs



Cost and Revenue Curves

o Average total costs - Costs calculated by dividing the sum of the variable and fixed costs by the number of units produced o Marginal cost - Change in total cost that results from producing an additional unit of output






Costs

2

3

Output FC VC TC ATC AVC MC

1 20 25 0

30

18


The Concept of Elasticity in Pricing Strategy

o Elasticity - Measure of responsiveness of purchasers and suppliers to a change in price o Elasticity of demand - Percentage change in the quantity of a good or service demanded divided by the percentage change in its price o Elasticity of supply - Percentage change in the quantity of a good or service supplied divided by the percentage change in its price


Price ($)

6

9

12

15

18

Elasticity Problem

Supply (Lbs) Demand (Lbs)

4 28

6 22

8

10

12

16

10

4


Elasticity and Revenue

o Elasticity has a strong influence on revenue o Example: Should Bay Area Rapid Transit System in San

Francisco raise or lower fares to increase revenues?

o • If fares decrease 10 percent, total revenue will fall unless the number of riders increases at least 10 percent. o • If fares increase 10 percent, total revenue will fall if more than 10 percent of the riders top using the subway. o Price cuts will increase revenues for products with elastic demand o Price increases will increase revenue for products with inelastic demand



Determinants of Elasticity

o Availability of substitutes or complements o Role as a complement to another product o Number of business transactions conducted online o Whether product is perceived as a necessity or luxury o Portion of a person’s budget spent on an item o Short run vs. long run demands



Practical Problems of Price Theory

o Many firms do not attempt to maximize profits o Demand curves are difficult to estimate


Price Determination in Practice

CHAPTER 18 Pricing Concepts o Cost-plus pricing - Uses a base-cost figure per unit and adds a markup to cover unassigned costs and to provide a profit o Allows businesses with low costs to set prices lower than those of competitors’ and still make a profit


Alternative Pricing Procedures

CHAPTER 18 Pricing Concepts o Full-cost pricing - Uses all relevant variable costs in setting a product’s price and allocates those fixed costs not directly attributed to the production of the priced item o No consideration of competition or demand for the item o Any method for allocating overhead is arbitrary and may be unrealistic



CHAPTER 18 Pricing Concepts o Incremental-cost pricing - Attempts to use only costs directly attributable to a specific output in setting prices



CHAPTER 18 Pricing Concepts o If firm is contracted for an additional 5,000 units, the lowest possible price would be $9/unit under full-cost pricing o Under incremental-cost pricing, prices above $5/unit are permitted:



Breakeven Analysis

o Pricing technique used to determine the number of products that must be sold at a specified price to generate enough revenue to cover total cost





Target Returns

o Most managers include a targeted profit in their analyses:



Evaluation of Breakeven Analysis

o Easily understood by marketers and nonmarketers o Assumes that costs can be divided into fixed and variable categories o Assumes that per-unit variable costs do not change at different levels of operation o Cost-based model that does not consider demand



The Modified Breakeven Concept

o Modifications that account for demand are necessary for effective pricing o Demand considerations include: o Degree of price elasticity o Consumer price expectations o Existence and size of specific market segments o Buyer perceptions of strengths and weaknesses of substitute products



The Modified Breakeven Concept

o Modified breakeven analysis - Pricing technique used to evaluate consumer demand by comparing the number of products that must be sold at a variety of prices to cover total cost with estimates of expected sales at the various prices







Yield Management

o Pricing strategy that allows marketers to vary prices based on such factors as demand, even though the cost of providing those goods or services remains the same o Example: Airfares, lodging, and auto rentals



Global Issues in Price Determination

o Prices must support the company’s broader goals o Domestic pricing strategies: o Profitability - If company is a price leader o Volume - Expose foreign markets to competition when trade barriers are lowered



Global Issues in Price Determination

o Meeting competition - Important in Europe where common currency has led to price convergence o Prestige - Valid when products are associated with intangible benefits, such as high quality, exclusiveness, or attractive design o Price stability - Important for producers of commodities who are more susceptible to fluctuating prices than producers of value-oriented products



Video

Watch Pricing Concepts at Evogear.com

o Do you believe Evo’s pricing strategy for evogear.com meets the five pricing objectives outlined in the text?

Provide examples for each objective.

o Do you think the opening of the 8,000-square-foot brickand-mortar store in Seattle distracts from their pricing strategy or enhances it? Why? To learn more about the brick-and-mortar store, visit culture.evogear.com/category/seattle/.


Chapter 5 Consumer Behavior

Chapter Objectives

Chapter Objectives

Pricing and the Law

Pricing and the Law

Robinson-Patman Act

Robinson-Patman Act

Unfair-Trade Laws

Fair-Trade Laws

Profitability Objectives

Reading Quiz 11 – Q. 4

Profitability Objectives

Volume Objectives

Sales vs. Profits

Meeting Competition Objectives

Value Pricing

Prestige Objectives

Pricing Objectives of Not-for-Profit

Organizations

Methods for Determining Prices

Price Determination in Economic Theory

Price Determination in Economic Theory

Cost and Revenue Curves

Cost and Revenue Curves

Costs

The Concept of Elasticity in Pricing Strategy

Elasticity Problem

Elasticity and Revenue

Determinants of Elasticity

Practical Problems of Price Theory

Price Determination in Practice

Alternative Pricing Procedures

Alternative Pricing Procedures

Alternative Pricing Procedures

Breakeven Analysis

Target Returns

Evaluation of Breakeven Analysis

The Modified Breakeven Concept

The Modified Breakeven Concept

Yield Management

Global Issues in Price Determination

Global Issues in Price Determination

Video

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