LECTURE 3
Pricing: concepts, models & analysis
This lecture draws heavily on what you have
studied in other courses such as Accounting
and Economics.
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Learning Objectives
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2
3
6
Definition and Overview
Demand analysis. Demand & Cost curves,Price elasticity
Experience curve, Review of costs & revenue
Cost issues, development & overhead costs
Fixed & Variable costs
7 Marginal analysis, Target ROR, Cost-based pricing
9 Problems with cost based pricing
10 Break-even Analysis. BE Market share
Additional – Supplementary notes are provided at the end
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Learning Outcomes
On completion of this unit, students should be able to:
• List and explain a variety of pricing objectives and what they
are trying to achieve
• Explain the role of demand and supply in price determination.
• Contextualise the following concepts: price sensitivity,
marginal analysis, break-even analysis, market share
• Give an overview of the determinants of price
• Understand price sensitivity and its implications for the
marketer
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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
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Marketers look at price differently
• Marketing has the broadest perspective on pricing
because it is the function that looks at both internal
cost issues and external pressure demands.
• Price means one thing to the consumer and another
to the seller. To the consumer, the price is the cost
of something; to the seller, price is the source of
profits. Marketing mangers find the task of setting
prices a challenge.
What Is Price?
Price
Price is that which is
given up in an exchange
to acquire a good or
service.
Notes:
1.Price is typically money exchanged for a good or service; however, it may
also be time lost while waiting to acquire the good or service.
2.Consumers are interested in obtaining a “reasonable price,” which means
a perceived reasonable value at the time of the transaction. The price
paid is based on the satisfaction consumers expect to receive from a
product and not necessarily the satisfaction they actually receive.
3.Price can relate to anything with perceived value, not just money. When
goods or services are exchanged, the trade is called barter.
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The Importance of Price to Marketing Managers
Revenue
Profit
The price charged to
customers multiplied by the
number of units sold.
Revenue minus expenses.
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Notes:
1.Prices are the key to revenues, which are the key to profits for an
organization.
2.Revenue is what pays for every activity of the company. What’s left
over is profit. The price is set to earn a profit for the company.
3.Managers strive to charge a price that will earn a fair profit. The
price must not be too high or too low, and must equal a perceived
value to consumers.
4.Lost sales mean lost revenue; on the other hand, if a price is too
low, the company loses revenue. Additionally, setting prices too low
may not attract as many buyers as managers might think.
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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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Notes:
1.Setting the right price can be a stressful task of marketing
managers, as demonstrated by the above trends in the
consumer market.
2.Consumers are using the Internet to make wiser and more
informed purchasing decisions.
3.Competition in general is increasing, and consequently many
installations, accessories, and parts are being marketed like
indistinguishable commodities.
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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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Profit-Oriented Pricing Objectives
Profit-Oriented Pricing Objectives
Profit
Maximisation
Target
Return on
Investment
Satisfactory
Profits
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Profit Maximisation
• Setting prices so that total revenue is as large as
possible relative to total costs.
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Return on Investment
Return
on
Investment
Net profit after taxes
divided by total assets.
ROI = Net Profit after taxes
Total assets
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Notes:
1.The most common profit objective is a target ROI, or the return on
total assets. It represents a firm’s effectiveness in generating profits
with the available assets. The higher the firm’s ROI, the better off the
firm is. ROI puts a firm’s profits into perspective by showing profits
relative to investment.
2.ROI needs to be evaluated in terms of the competitive environment,
risks in the industry, and economic conditions. In general, firms seek
ROIs in the 10 to 30 percent range, depending on the industry. For
example GE seeks a 25 percent ROI, while grocery chains obtain a
return under 5 percent.
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Sales-Oriented Pricing Objectives
Sales-Oriented Pricing Objectives
Market
Share
Sales
Maximization
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Market Share
Market Share
A company’s product sales as a
percentage of total sales for that
industry.
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Notes:
1.Market share can be reported in dollars or units of product, and the
results may be different.
2.Many companies believe that maintaining or increasing market
share is an indicator of the effectiveness of their marketing mix.
Larger shares often mean higher profits, thanks to economies of
scale, market power, and ability to compensate top-quality
management.
However, this conventional wisdom is not always reliable.
3.Many companies with low market share survive if they are in a slow
growth industry and experience few product changes.
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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
Maximization of cash should never be a long-run objective because
cash maximization may mean little or no profitability. Without
profits, a company cannot survive.
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Status Quo Pricing Objectives
Status Quo Pricing Objectives
Maintain
existing
prices
Meet
competition’s
prices
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Notes:
1.Status quo pricing seeks to maintain existing prices or to meet the
competition’s prices.
2.This category requires little planning, and is essentially a passive
policy.
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REVIEW LEARNING OUTCOME
Pricing Objectives
Profit-Oriented
Profit
Maximization
Satisfactory
Profits
Target
ROI
Status Quo
Sales-Oriented
Market
Share
Sales
Maximization
Maintain
Existing Price
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The Demand Determinant of Price
Explain the role of demand
in price determination
1.After pricing goals are established, specific prices are set.
2.The price set for products depend on two factors: the demand for the
good and the cost to the seller for that good.
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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 specific period.
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The Demand Curve
The Supply Curve
Tyson’s Meat Glut
• Tyson Foods, the world’s largest processor, has an oversupply of meat:
– Lower chicken consumption due to avian flu fears
– export restrictions to Japan and South Korea
due to mad cow disease
• Mismatch between oversupply and reduced demand has created
tremendous financial losses for the company.
• Tyson produces 25% of meats that Americans eat, and small price
changes impact company profit significantly.
• To reverse trend, company is taking a commodity approach to the primary
business, while marketing more value-added products.
SOURCE: Richard Gibson, “Tyson Looks for Way Out of Meat Glut,” Wall Street Journal, June 28, 2006, B9A.
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Price Sensitivity Drivers - Exhibit 6-4
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SELF REVIEW
• Understand that value is not the only determinant of
a customer’s willingness to pay
• Identify key factors determining price sensitivity and
recognize how these factors can be influenced by
marketers?
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
Notes:
1.An equilibrium price is reached when supply and demand are equal.
2.A price below equilibrium results in a shortage because the demand is
greater than the available supply. A shortage puts upward pressure on
price.
3.At a price above equilibrium, the demand is less than the available
supply, and a surplus is created. A surplus lowers the price.
4.Establishing an equilibrium price may not be possible all at once.
Prices may fluctuate as the market for a good moves toward
equilibrium; however, demand and supply will settle into the proper
balance.
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Elasticity of Demand
Elastic
Demand

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.

An increase in sales exactly offsets a
decrease in prices,
and revenue is unchanged.
Unitary
Elasticity
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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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Elasticity of Demand
Price Goes...
Revenue Goes...
Demand is...
Down
Up
Elastic
Down
Down
Inelastic
Up
Up
Inelastic
Up
Down
Up or Down
Elastic
Stays the Same
Unitary Elasticity
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Elasticity of Demand
Factors that Affect Elasticity of Demand
Availability of substitutes
Price relative to
purchasing power
Product durability
A product’s other uses
Rate of inflation
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Notes:
Factors that affect elasticity of demand are:
1.Availability of substitutes: When many substitutes are available, it is
easy to switch products, making demand elastic. The same is true in
reverse, if no substitutes are available.
2.Price relative to purchasing power: If a price is so low that it is an
inconsequential part of an individual’s budget, demand will be
inelastic and people are not sensitive to the price increase.
3.Product durability: Repairing durable products rather than replacing
them prolongs their useful life. If the cost of a new product
increases, people might elect to repair the old product. Thus, people
are sensitive to the price increase, and the demand is elastic.
4.A product’s other uses: The greater the number of uses for a
product, the more elastic demand tends to be. If a product has only
one use, the quantity purchased probably will not vary as price
varies.
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Review:
Discuss examples of price inelasticity and elasticity. Include zero percent
automobile financing, the price of vehicle models, cell phone rates,
prestige watches, cigarettes, health care, textbooks.
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Will Travel For Savings (2013 US Study)
Some 81% of shoppers said they would drive 5 to 10 minutes out their way (round trip) for a $10
rebate on a $50 product; 93% said they would drive that distance for a $20 discount
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Price-sensitive shoppers are highly motivated to seek value. They will compare prices
between brands, and are committed to finding and using coupons.
These characteristics present challenges for businesses when attempting to engage
and develop brand loyalty among price-sensitive shoppers, but the group should not be
ignored in marketing initiatives.
Evidence shows that price-sensitive shoppers are often the highest-spending group
among a given product’s consumers.
Price-sensitive shoppers can easily comprise the majority of a given brand’s
consumers. In a study of a multi-category food brand, around 60 percent of all buyers
were found to be “price-sensitive” or “very-price-sensitive” by the firm’s classification.
Among average households, the brand studied got $188 in sales annually from pricesensitive shoppers versus $168 for households in the “least-price-sensitive” group. The
study defined price-sensitive shoppers based on coupon use, consistency in
purchasing lower-price items and frequency of buying items on promotion.
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The Cost Determinant of Price
Describe cost-oriented
pricing strategies
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Notes:
1.Sometimes the importance of demand is ignored when prices are
decided, based largely or solely on the basis of costs.
2.Prices set on the basis of cost may be too high for the target market.
On the other hand, if prices are set too low, the firm will earn a lower
return than it should.
3.Costs should be determined as part of any price determination, in part
to determine the floor below which a good or service must not be
priced in the long run.
4. Variable and fixed costs are important aspects of price determination.
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REVIEW LEARNING OUTCOME
Cost-Oriented Pricing Strategies
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The Impact of the Internet
Product selection
Second opinions from expert sites
Shopping bots
Internet auctions
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Notes:
1.The Internet connects sellers and buyers quickly, and allows product and
price comparison, putting them in a better bargaining position.
2.Numerous Web sites provide information regarding product selection, and
a second opinion for brand selection. However, quality of reviews vary.
3.Shopping bots search the Web for the best price. The two types of
shopping bots are broad-based types and niche-oriented types. Most
shopping bots give preferential listings to e-tailers who pay for the
privilege, and not necessarily the lowest-priced retailer.
4.Internet auctions, such as eBay, are huge. Business-to-business
auctions are likely to be the dominant form in the future.
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The Relationship of Price to Quality
Prestige Pricing
Charging a high price to
help promote a highquality image.
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Notes:
1.When a purchase decision involves uncertainty, consumers tend to
rely on a high price as a predictor of good quality. Consumers
assume that “you get what you pay for.”
2.Prestige pricing takes these consumer attitudes into account when
devising price strategies. A successful prestige pricing strategy
requires a retail price that is reasonably consistent with consumers’
expectations.
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Exercise:
Vivre is a luxury lifestyle catalog and Web site. Visit Vivre.com and
review the product offerings. Pick a product and then see if you can get
it cheaper at Ashford.com, a luxury brand discounter. What luxury
brands are offered on both sites? How do the prices compare? Can
you identify tiers of luxury brands?
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Markup Pricing
Markup
Pricing
The cost of buying the
product from the producer
plus amounts for profit and
for expenses not
otherwise accounted for.
Keystoning
The practice of marking up
prices by 100%, or doubling
the cost.
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Notes:
1.Markup pricing is the most popular method to establish a selling price.
Instead of using the costs of production to set price, it uses the costs of
buying the product from the producer, plus amounts for profit and
expenses.
The total determines the selling price.
2.Keystoning is a method based on experience, with many small retailers
doubling the cost. Other factors that influence markups are the
merchandise’s appeal to customers, past response to the markup, the
item’s promotional value, the seasonality of the goods, their fashion
appeal, the product’s traditional selling price, and competition.
3.The biggest advantage of markup pricing is its simplicity. The primary
disadvantage is that it ignores demand and may result in overpricing or
underpricing the merchandise.
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Demand Curve
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Inelastic and Elastic Demand
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Cost as a Function of Production Experience
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Demand Curves
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Demand For Medium Sized Imported Sedans
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Demand For Volvo S 40
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