CHAPTER 7
Pricing Products: Pricing Considerations and
Strategies
Objective: looking at the factors when setting prices
and examining the pricing strategies by focusing on
the problem of setting prices.
Factors to Consider
When Setting Prices
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A company’s pricing decisions are affected by;
internal company factors
external environmental factors
Internal Factors
Affecting Pricing Decisions
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Internal factors that affect pricing decisions
include;
the company’s marketing objectives
marketing-mix strategy
costs
organization
Marketing Objectives
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Before setting a price, the company must decide on
its overall strategy (target market, and positioning,
then its marketing mix). E.g. if a car manufacturer
decides to produce a new sports car for the highincome segment, then the company must charge a
high price.
Then the company must consider its objectives,
before setting its price. Objectives would be;
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survival; if a company is in trouble because over capacity,
heavy competition, or changing consumer wants, in order
to survive and increase demand, the
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company may set a low price. Here, the profits are less
important than survival. If the prices cover the costs,
they can stay in business but survival is only a short-term
objective.
current profit maximization; some companies estimate what
demand and costs will be at different prices and choose
the price that will produce the maximum current profit.
Here, short-term financial results (cash flow) are more
important than long-run performance.
market-share leadership; some companies believe that the
company with largest market share will enjoy the lowest
costs and highest long-run profit. That is why, in order to
become the market-share leader, they set their prices as
low as possible.
product-quality leadership; if a company wants to become the
product-quality leader, it charges a high price to cover the
costs of R&D.
Marketing-Mix Strategy
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Decisions made for the other marketing mix variables
affect pricing decisions. The marketer must consider
the total marketing mix when setting prices.
There are two alternatives. Either price positioning
determines the product’s marketing mix or nonprice
positioning determines the product’s marketing mix.
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In price positioning; the company makes its pricing decision first
and then makes other marketing-mix decisions on the prices
that they want to charge. This
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technique is called target costing which reverses the
usual process of first designing a new product,
determining its cost, and then asking the consumers how
much they can pay for it. Instead it starts with a target
cost and price in mind and works back. E.g. Compaq
Computer Corporation calls this process “design to
price”. Starting with a price target set by marketing, and
with profit margin goals from management, the company
determine what costs had to be in order to charge the
target price for its “Prolinea personal computer line”.
In nonprice positioning; the company deemphasize price and
use other marketing-mix tools to differentiate the
marketing offer to make it worth a higher price. They
believe that the best strategy is not to charge the lowest
price because customers do not buy on price alone.
Instead they seek products that give them the best value
for their money.
Costs
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Costs set the floor for the price that the
company can charge for its product. The
company wants to charge a price that both
covers all its costs for producing, distributing,
and selling the product and provides a fair
profit.
A company’s costs are two types: fixed and
variable.
Fixed costs (also known as overhead) are those
that do not vary with production or sales level
e.g. rent, interest, heat, executive salaries.
 Variable costs vary directly with the level of
production e.g. supplies.
 Total costs are the sum of the fixed and variable
costs for any given level of production.
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Management wants to charge a price that will
at least cover the total production costs at a
given level of production.
Organizational Considerations
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Management must decide who will set the prices in the company.
In small companies, prices are set by the top management.
In large companies prices are set by divisional or product line
managers.
In industrial markets, salespeople may be allowed to negotiate
with customers within certain price ranges set by the top
management.
In industries where pricing is a key factor (railroads, oil
companies…) there are pricing departments reporting to the
marketing department or top management.
External Factors
Affecting Pricing Decisions
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External factors that affect pricing decisions
include;
the nature of the market and demand
competition
other environmental elements
The Market and Demand
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Before setting prices, the marketer must
understand the relationship between price and
demand for its product with the help of the
following;
pricing in different types of markets
 consumer perceptions of price and value
 analyzing the price-demand relationship
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Pricing in Different Types of Markets
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The seller’s pricing freedom varies with different types
of markets. Economists recognize four types of
markets which require different pricing methods.
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under pure competition; the market consists of many
buyers and sellers trading in a uniform commodity such as
wheat, copper… No single buyer or seller has much effect on
the going price. A seller cannot charge more than the going
price because buyers can obtain as much as they need at the
going price. A seller cannot charge less as well, because they
can sell all they want at this
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price. Here, marketing research, product development,
pricing, advertising and sales promotion play little or no
role.
under monopolistic competition; the market consists
of many buyers and sellers who trade over a range of
prices than a single market price. A range of prices occurs
when buyers see differences in sellers’ products and are
willing to pay different prices form them. Sellers try to
develop differentiated offers (with advertising,
branding…) for different customer segments.
under oligopolistic competition; the market consists of
a few sellers who are highly sensitive to each other’s
pricing and marketing strategies. The product can be
uniform (steel, aluminum...) or nonuniform (cars,
computers…). There are few sellers because it is
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difficult for new sellers to enter the market. Each seller is
alert to competitors’ strategies and moves. If a steel
company decreases its price by 10 percent, buyers quickly
switch to this supplier. So that the other steelmakers must
respond by lowering their prices or increasing their
services. Here it is not certain that they will get
permanent results through such price cuts.
In a pure monopoly, the market consists of one seller. It
would be a government monopoly, a private regulated
monopoly, or a private nonregulated monopoly. Pricing
is handled differently in each case. A government
monopoly may have three objectives. (1) It might set a
price below cost because the product is important for the
buyers who cannot afford to pay full cost. (2) Or the
price might be set either to cover costs
or to produce good revenue. (3) It can be set quite high to
slow down consumption. In a regulated monopoly, the
government permits the company to set rates (but that
should yield a “fair return”). In a nonregulated monopoly,
the company is free to set a price at what the market will
bear. But they may not charge the highest price for a number
of reasons: (1) not to attract competition, (2) to penetrate the
market faster with a low price, or (3) to prevent government
regulation.
Consumer Perceptions of Price and Value
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The consumer decides whether a product’s price is right.
That is why, pricing decisions are buyer oriented like the
other marketing-mix decisions.
Effective buyer-oriented pricing involves understanding how
much value consumers give to the product and setting a price
that fits this value. But is not easy to measure the value
(intangible values are included e.g. taste, environment,
status…) that consumers give to the product.
If consumers perceive that the price is greater than the
product’s value, they do not buy the product. If consumers
perceive that the price is below the product’s value, they buy
but then the seller loses from its profit opportunities.
Analyzing The Price-Demand Relationship
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Each price that the company might charge will lead to a different
level of demand.
In the normal case, demand and price are inversely related: the
higher the price, the lower the demand.
In the case of prestige goods, the demand curve sometimes
slopes upward e.g. one perfume company found that by raising
its price, it sold more perfume rather than less. Consumers
thought that the higher price meant a better perfume.
Most companies try to measure their demand curves by
estimating demand at different prices.
Price Elasticity of Demand
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Marketers need to know price elasticity - how
responsive demand will be to a change in price. If
demand hardly changes with a small change in price, we
say that the demand is inelastic. If demand changes
greatly, we say that the demand is elastic.
Buyers are less price sensitive;
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when the product is unique or high quality or prestige
when substitute products are hard to find or when they
cannot easily compare the quality of substitutes
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when the total expenditures for a product is low relative
to their income or when the cost of buying a product is
shared by another party.
If demand is elastic, sellers lower their price. A
lower price produces more total revenue when the
extra costs of producing and selling do not exceed
the revenue.
A. Inelastic demand
P2
P1
B. Elastic Demand
P2
P1
Q2 Q1
Quantity demanded per period
Q2
Q1
Quantity demanded per period
Competitors’ Costs, Prices, and
Offers
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Another external factor affecting the company’s pricing
decisions is competitors’ costs and prices and reactions to
the company’s own pricing moves.
The company’s pricing strategy may affect the nature of the
competition e.g. if a company follows a high-price strategy,
it may attract competition. A low-price strategy may stop
competitors or drive them out of the market. Here, the
company must learn the price and quality of each
competitor’s offer and price its offer relative to competition.
Other External Factors
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Some other factors must be considered when pricing;
economic conditions; such as boom or recession, inflation,
and interest rates affect pricing because they affect (1)
the costs of production and (2) consumer perceptions
of the product’s price and value.
resellers; should be considered in pricing because they
should get a fair profit so that they help the company to
sell its products.
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government; laws that affect pricing must be known so
that the company makes sure that their pricing
policies are defensible.
social concerns; the company’s sales, market share,
profit goals must be viewed by societal
considerations.
General Pricing Approaches
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Companies set prices by selecting a general pricing
approach that includes one or more of the following
factors: (1) product cost, (2) consumer perceptions of the
product’s value - demand, (3) competitor’s prices and other
external and internal factors.
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Following pricing approaches are possible to use;
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the cost-based approach (cost-plus pricing, break-even
analysis, and target profit pricing)
the buyer-based approach (value-based pricing)
the competition-based approach (going-rate and sealedbid pricing)
Major Considerations in Setting Price
LOW PRICE
No possible
profit at
this price
Product
costs
Competitor’s prices
and other external
and internal factors
Consumer
perceptions
of value
HIGH PRICE
No possible
demand at
this place
Cost-Based Pricing
A) Cost-plus pricing “markup pricing”;
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is the simplest pricing method in which a standard
mark-up (profit margin) is added to the cost of the
product e.g. the cost of producing a toaster is $16
and the producer wants to make a 25% profit,
therefore sets the price at $20.
the biggest benefits of this approach is that when all
the companies use this approach, price competition
is minimized.
B) Break-even pricing or target profit
pricing;
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in which the firm tries to determine the price at
which it will break even or make the target profit
that it wants.
Target pricing uses the concept of a break-even
chart, which shows the total cost and total revenue
expected at different sales volume levels.
E.g. fixed costs are $6 million, variable costs are $5
per unit. The total revenue curve reflects the price.
If the revenue is $12 million on 800.000 units, the
price is $15 per unit.
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At the $15 price, the company must sell at least
600.000 units to break even where the total revenues
equal to total costs, $9 million. If the company
wants to target $2 million profit, it must sell at least
800.000 units to obtain $12 million total revenue
needed to cover $10 million total costs.
The higher the price, the lower the company’s breakeven point. But as the price increases, demand
decreases. Although this approach helps the
company to determine minimum prices needed to
cover its expected costs and profits, they do not take
the price-demand relationship into consideration.
Break-even Chart for Determining Target
Price
Dollars
Total revenue
Target profit ($2 million)
12
10
8
6
4
2
0
Total cost
Fixed cost
200
400
600
800
1000
Sales volume in units
(thousands)
Buyer-Based Pricing
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uses buyer’s perceptions of value as the key to
pricing. Here, the marketer set the price based on
the consumer’s desires and then design the product
and the other marketing-mix variables.
Cost-based pricing is product driven, but buyerbased pricing is consumer driven. Therefore, it
begins with analyzing consumer needs and value
perceptions.
Competition-Based Pricing
A) Going-rate pricing;
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in which a firm bases its prices on competitor’s
prices. The firm might charge the same, more or
less than its competitors.
Going-rate pricing is popular when elasticity of
demand is hard to measure and when the firms do
not want harmful price wars.
B) Sealed-bid pricing;
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in which a firm bases its price on how it thinks
that competitors will price. Here, the firm wants
to win a contract and winning the contract
requires pricing less than other firms.
New-Product Pricing Strategies
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Pricing strategies usually change as the product passes
through its life-cycle. At the introduction stage, basically
there are two types of products - imitations of existing
products and innovative patent-protected product.
A company with an innovative patent-protected product
has two pricing strategies;
 Market-skimming pricing
 Market-penetration pricing
Market-Skimming Pricing
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When a new product is introduced, the company
charges the highest price that it can to skim (as
skimming the cream on the top of the fresh
milk) the market. The objective is to earn the
highest possible gross profit. As initial sales slow
down, and competitors start to introduce similar
products, the company must lower its prices.
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Here, the company skim off small but
profitable market segments.
Market skimming makes sense; (1) when the
product’s quality and image support its high
price and enough buyers want it at that price,
(2) when the costs of producing a smaller
volume are not so high that they eliminate the
advantages of charging more, (3) when
competitors do not enter the market easily
and cut the prices.
Market-Penetration Pricing
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Market-penetration pricing is that setting a low price
for a new product in order to attract a large number
of buyers and a large market share.
The high sales volume results in falling costs which
helps the company to cut its price even more.
Market-penetration makes sense; (1) when the
market is price sensitive (2) When production and
distribution costs fall as sales volume increases, (3)
when the low price keeps the competitors away.
Product-Mix Pricing Strategies
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When the new products is part of product mix, the
strategy for setting a product’s price often has be
changed. Here, the firm looks for a set of prices
that maximizes the profits for the total product mix.
The product-mix pricing strategies are;
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product line pricing
optional-product pricing
captive-product pricing
by-product pricing
product-bundle pricing
Product Line Pricing
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Companies usually develop product lines rather than single
products e.g. Nike, Kodak have serious of products in the
same product category. In product-line pricing, the
company must decide on the price steps to set between the
various products in the line.
The price steps should take into account; (1) cost
differences between the products, (2) customer evaluations
of their different features, (3) competitors’ prices. Here, the
marketers task is to establish perceived quality differences
that support the price differences.
Optional-Product Pricing
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Optional-product pricing offers to sell optional
or accessory products along with their main
product e.g. nowadays automobile companies
like Ford offer a set of popular options such as
air conditioning, power windows and door locks,
and a rear window defroster at a package price.
Captive-Product Pricing
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Captive-product pricing is setting a price for products
that must be used along with a main product.
Producers of the main products (e.g. computers,
cameras...) often price them low but charge more for
the supplies e.g. Polaroid prices its cameras low but
camera films high where it makes its profit. Or Gilette
sells low-prices razors but makes money on the
replacement blades.
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This strategy is called two-part pricing. The price of
the service is broken down into a fixed fee plus a
variable usage rate. E.g. a telephone company
charges a monthly rate (the fixed fee) plus charges
for extras (the variable usage rate). Amusement
parks charge admission plus fees for food,
attractions and rides over a minimum number. The
fixed amount should be low enough to attract usage
of the service; profit is made on the variable fees.
By-Product Pricing
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Setting a price for by-products in order to make
the main product’s price more competitive.
In by-product pricing, the manufacturer looks
for a market that would buy the company’s byproducts and accepts the price that covers more
than the cost of storage and delivery.
Product-Bundle Pricing
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Combining several products and offering the
bundle at a reduced price. E.g. season tickets of
sports teams is cheaper than the cost of single
tickets, hotels’ and agencies’ special priced
packages, software packages of computer
makers.
This approach can promote the sales of
products that consumers might not otherwise
buy, but the combined price must be low enough
to get them to buy the bundle.
Price-Adjustment Strategies
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Companies adjust their prices according to the
differences in customers and changing situations. There
are several price adjustment strategies;
discount and allowance pricing
segmented pricing
psychological pricing
promotional pricing
geographic pricing
international pricing
Discount and Allowance Pricing
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Discount is a straight reduction in price on
purchases during a stated period of time. There are
different types of discounts;
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cash discount; is a price reduction to buyers who pay their
bills promptly.
quantity discount; is a price reduction to buyers who
purchase in large volume.
functional discount (trade discount); is offered by the seller to
trade channel members who perform certain functions
like selling, storing, record keeping.
seasonal discount; is a price reduction to buyers who
purchase merchandise or services out of season.
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Allowances are another type of reduction from the
list price.
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trade-in allowances; are price reductions given for turning in
an old item when buying a new one which is common in
the automobile industry
promotional allowances; are payments or price reductions to
reward dealers for participating in advertising and salessupport programs.
Segmented Pricing
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Adjusting the basic prices to allow differences in
customers, products, and locations. In this approach,
the company sells a product or service at two or more
prices. There are different segmented pricing forms;
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in customer-segment pricing; different customers pay different
prices for the same product or service e.g. museums charge
students and senior citizens lower.
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in product-form pricing; different versions of the product are
priced differently but not according to differences in their
costs e.g. the most favorite or top model of the product
line may have higher price.
in location pricing; a company charges different prices for
different locations, even though the cost of offering each
location is the same e.g. theatres vary their seat prices,
universities charge higher tuition for out-of-state students
in time pricing; a firm varies its price by the season, the
month, the day, and even the hour e.g. telephone
companies offer lower “off-peak” charges, resorts give
seasonal discounts.
Psychological Pricing
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Price says something about the product, especially about its
quality.
in psychological pricing; sellers consider the psychology of
prices rather than economics.
E.g. Heublein priced its new vodka brand high against
Smirnoff which gave the customers the impression that
Heublein is better than Smirnoff, therefore, the sales grow
rapidly.
The difference between $300 and $299.95 is just five cents
but the psychological difference can be much greater. Some
consumers will see the $299.95 as a price in the $200 range
rather than the $300 range.
Promotional Pricing
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Temporarily pricing products below list price,
and sometimes even below cost, to increase
short-run sales. There are several forms;
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loss leaders; supermarkets generally price a few items
as loss leaders to attract customers to the store in the
hope that they will buy other items at normal
markups.
special-event pricing; products are priced low in
certain seasons to draw more customers.
 cash rebates; are offered to customers who buy the
product from dealers within a specified time.
Rebates would be offered as low-interest financing,
longer warranties, or free maintenance to reduce the
consumer’s price.
 discounts; would be offered to reduce the price for
the customer.
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Geographic Pricing
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Deciding how to price products for customers located
in different parts of the country or world. Here, the
company must decide whether to charge the distant
customers higher to cover its shipping costs.
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in FOB-origin pricing (free-on-board); the customer is
responsible to pay for the shipping.
in uniform delivery pricing; the company charges the same price
plus the average shipping cost, regardless of the customer’s
location.
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in zone pricing; the company sets up two or more zones.
All customers within a given zone pay a single total price;
the more distant the zone, the higher the price.
in basing-point pricing; the seller selects a given city as a
“basing point” and charges all customers the shipping
cost from that city to the customer location.
in freight(cargo)-absorption pricing; the seller absorbs (covers)
all or part of the actual freight (shipping) charges to get
some desired customers.
International Pricing
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Companies that market their products internationally
must decide what prices to charge in different countries.
The company either set a uniform price or adjust their
prices to reflect local market conditions.
Factors that influence price adjustment would be;
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economic conditions
competitive situations
laws and regulations
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costs e.g. a pair of Levis is sold for $30 in the US, but $63
in Tokyo and $88 in Paris. Or McDonald’s Big Mac is
$2.25 in the US but $5.75 in Moscow.
Selling strategies and market conditions e.g. a Gucci
handbag is $60 in Milan but $240 in the US.