Pricing the Product
Chapter Objectives
• Explain the importance of pricing and how prices
can take both monetary and nonmonetary forms
• Understand the pricing objectives marketers
typically have in planning pricing strategies
• Describe how marketers use costs, demands,
and revenue to make pricing decisions
• Understand some of the environmental factors
that affect pricing strategies
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Chapter Objectives (cont’d)
• Understand key pricing strategies
• Explain pricing tactics for single and
multiple products, and for pricing on the
Internet
• Understand the opportunities for Internet
pricing strategies
• Describe the psychological, legal, and
ethical aspects of pricing
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Real People, Real Choices
• Taco Bell (Danielle Blugrind)
• In order to differentiate itself
from the competition, Taco Bell
needed to update its value
pricing menu.
Option 1: price entire menu
at $1.29
Option 2: price items at 99
cents and $1.29
Option 3: price items at
99 cents, $1.19, and $1.29
TACO BELL
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“Yes, but what does it cost?”
• Price: the assignment of
value, or the amount the
consumer must exchange
to receive the offering
Money, goods, services, favors,
votes, or anything else that has
value to the other party
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Figure 11.1:
Steps in Price Planning
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Step 1: Develop Pricing Objectives
•
•
•
•
•
Sales or market share objectives
Profit objectives
Competitive effect objectives
Customer satisfaction objectives
Image enhancement objectives
ROLLS-ROYCE
7
Step 2: Estimate Demand
• Demand: customers’
desires for a product
How much of a product are
customers willing to buy as
its price goes up or down?
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Demand Curves
• Law of demand: as price goes up, quantity
demanded goes down.
• For prestige products, a price increase
may actually result in an increase in
quantity demanded.
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Figure 11.2: Demand Curves for
Normal and Prestige Products
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Shifts in Demand Curve
Changes in marketing strategy
(improved product, new
advertising) or non-marketing
activities can cause upward or
downward shifts in demand.
At a given price, demand is greater
or less than before the shift.
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Figure 11.3: Shift in Demand Curve
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Estimating Demand
• Marketers predict total demand by
estimating potential buyers for a product,
then multiplying number of buyers times
average amount of each buyer’s purchase.
• Then they predict what the company’s
share of the total market will be.
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Price Elasticity of Demand
• The percentage change in unit sales that results
from a percentage change in price.
Figure 11.5: Price Elastic and Inelastic Demand Curves
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Elastic Demand
• A change in price results in
a substantial change in
quantity demanded.
If price is increased, revenues
decrease, and vice-versa.
Non-necessities (pizza)
generate elastic demand.
Availability of close substitute
products facilitates elastic demand.
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Inelastic Demand
• A change in price has little or no effect on
quantity demanded.
 If price is increased, revenues increase.
 The demand for necessities (food and electricity) is
generally inelastic.
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Cross-elasticity of Demand
• Changes in prices of other products affect
a product’s demand.
 Products are substitutes: increase in price of one will
increase demand for other (bananas vs.
strawberries).
 One product is essential for use of second: increase
in price of one decreases demand for other
(increasing price of gas lowers demand for tires).
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Group Activity
• Your group are marketers for a candy bar manufacturer.
You feel it’s time to increase price, but you’re concerned
the increase might not be profitable.
--How would you investigate elasticity of demand?
--What findings would lead you to increase price?
--What findings would lead you not to increase it?
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Step 3: Determine Costs
• Variable costs: costs of production that are
tied to and vary depending on the number
of units produced.
 Average variable costs may change as the number of
products produced changes.
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Figure 11.6: Variable Costs at Different
Levels of Production
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Step 3: Determine Costs (cont’d)
• Fixed costs: costs of production that don’t
change with number of units produced
Rent, cost of owning/maintaining factory, utilities,
equipment, fixed salaries of firm’s executives
Average fixed cost: fixed cost per unit (total fixed costs
divided by number of units produced) will decrease as
number of units produced increases.
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Step 3: Determine Costs (cont’d)
• Total costs: total of fixed costs and
variable costs for a set number of units
produced.
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Break-Even Analysis
• A method for determining the number of
units a firm must produce and sell at a
given price to cover all its costs.
• Break-even point: point at which a firm
doesn’t lose any money and doesn’t make
any profit.
Song Airlines
Video
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Figure 11.7: Break-Even Analysis
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Break-Even Analysis (cont’d)
• Break-even point (in units) = (total fixed
costs) divided by (contribution per unit)
 Contribution per unit: the difference between the price
the firm charges for a product and the variable costs
• Break-even point (in dollars) = (total fixed
costs) divided by [1 - (variable cost per
unit divided by price)]
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Marginal Analysis
• A method that uses cost and demand to
identify the price that will maximize profits.
 Marginal cost: increase in total costs from producing
one additional unit of a product
 Marginal revenue: increase in total income or revenue
from selling one additional unit of a product
(decreases with each additional unit sold)
 Profit is maximized where marginal cost is exactly
equal to marginal revenue.
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Figure 11.8: Marginal Analysis
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Marketing Math Activity
• You and your friend have decided to go
into business together manufacturing
handbags.
 --You know fixed costs will be $120,000 a year, and
you expect variable costs to be $28 per bag.
 --If you plan to sell the bags to retail stores for $35,
how many must you sell to break even?
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Step 4: Evaluate the Pricing
Environment
• The economy
Broad economic trends
Recessions,
Inflation
• The competition
• Consumer trends
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Step 5: Choose a Price Strategy
• Pricing strategies
based on cost
Simple to calculate and
relatively risk free
Cost-plus pricing: total all
product costs and add
markup
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Step 5: Choose a Price Strategy
(cont’d)
• Pricing strategies based on demand
 Based on estimate of quantity a firm can sell at
different prices
 Target costing: identify quality and functionality
customers need and price they’re willing to pay before
designing product.
 Yield management pricing: charge different prices to
different customers to manage capacity
PRICELINE.COM
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Step 5: Choose a Price Strategy
(cont’d)
• Pricing strategies based on the
competition
 Pricing near, at, above, or below the competition
 Price leadership strategy: industry giant announces
price, and competitors get in line or drop out
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Discussion
• In what ways is a price leadership strategy
good or bad for consumers?
• Should governments allow price
leadership?
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Step 5: Choose a Price Strategy
(cont’d)
• Pricing strategies based on customers’
needs
 Value pricing or everyday low pricing (EDLP): pricing
strategy in which a firm sets prices that provide
ultimate value to customers.
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Step 5: Choose a Price Strategy
(cont’d)
• New-product pricing
Skimming price: a very high premium
price
Penetration pricing: a very low price
to encourage more customers to
purchase
Trial pricing: low price for a limited
period of time
HP FINANCIAL CALCULATORS
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Discussion
• In pricing new products, marketers may
choose a skimming or a penetration
pricing strategy.
 --What is the advantage or disadvantage of this
practice for consumers?
 --For the industry as a whole?
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Step 6: Develop Pricing Tactics
• Pricing for individual
products
Two-part pricing: offering two
separate types of payments to
purchase the product
Payment pricing: breaking total
price into smaller amounts
payable over time
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Step 6: Develop Pricing Tactics (cont’d)
• Pricing for multiple products
Price bundling: selling two or more goods or services as
a single package for one price
Captive pricing: pricing two products that work only
when used together
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Step 6: Develop Pricing Tactics (cont’d)
• Distribution-based pricing
F.O.B. (free on board) origin pricing
F.O.B delivered pricing
Basing-point pricing
Uniform delivered pricing
Freight absorption pricing
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Step 6: Develop Pricing Tactics (cont’d)
• Discounting for channel members
 List price (suggested retail price): price that
manufacturer sets as appropriate for end consumer to
pay
 Trade or functional discounts: set percentage
discounts off list price for each channel level
 Quantity discounts: reduced prices for purchases of
larger quantities
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Step 6: Develop Pricing Tactics (cont’d)
• Discounting for channel members
(continued)
Cash discounts: enticements to customers to pay bills
quickly (2% 10 days, net 30 days)
Seasonal discounts: price reductions offered during
certain times of year
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Pricing and Electronic Commerce
• Dynamic pricing
strategies: seller easily
adjusts price to meet
changes in marketplace.
Cost of changing prices on Internet
is practically zero.
Firms can respond quickly and
frequently to changes in costs,
supply, and/or demand.
CHEAPTICKETS.COM
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Pricing and Electronic Commerce
(cont’d)
• Online auctions (eBay.com)
 E-commerce allows shoppers to purchase products
through online bidding.
• Pricing advantages for online shoppers
 Consumers gain control.
 Search engines and “shopbots” make customers
more price-sensitive.
 Consumers have more negotiating power.
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Psychological Issues in Pricing
• Buyer’s pricing expectation
 Internal reference price: consumers use a price/price
range to evaluate product’s cost.
• Assimilation effect
• Contrast effect
 Price/quality inferences: consumers assume higherpriced product has higher quality.
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Discussion
• Consumers often make
price-quality inferences
about products.
--What are some products for
which you make price-quality
inferences?
--Do your inferences make
sense?
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Psychological Pricing Strategies
• Odd-even pricing: prices
ending in 99 rather than 00
lead to increased sales.
• Price lining: items in a
product line sell at different
price points.
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Legal and Ethical Considerations in
Pricing
• Deceptive pricing practices
 Going-out-of-business sale
 Bait-and-switch
• Unfair sales acts
 Loss-leader pricing
 Unfair sales acts
• Illegal business-to-business price
discrimination
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Discussion
• In loss-leader pricing, retailers advertise
and sell an item below cost to get
customers into the store.
 --Do you consider this an unethical practice?
 --Who benefits and who is hurt by it?
 --Should the practice be made illegal (some states
have done so)?
 --How is loss-leader pricing different from bait-andswitch pricing?
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Legal and Ethical Considerations in
Pricing (cont’d)
• Price fixing: two or more
companies conspire to keep
prices at a certain level
Horizontal price fixing
Vertical price fixing
• Predatory pricing: company
sets a very low price for
purpose of driving competitors
out of business
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Real People, Real Choices
• Taco Bell (Danielle Blugrind)
• Danielle chose option 3:
price items at 99 cents,
$1.19, and $1.29
By carefully tuning its pricing strategy,
Taco Bell is reclaiming its position as
purveyor of fast-food value for the
money.
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Marketing Plan Exercise
• A new seaside resort offers luxury rentals for
a few days, a week, or longer. Consider
possible pricing strategies -- cost-plus, yield
management, everyday low pricing,
skimming, and penetration and trial pricing.
 --What pricing strategy do you
 recommend for the resort ?
 --What pricing tactics do
you suggest?
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Marketing in Action Case:
You Make the Call
• What is the decision facing True Religion?
• What factors are important in
understanding this decision situation?
• What are the alternatives?
• What decision(s) do you recommend?
• What are some ways to implement your
recommendation?
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Keeping It Real: Fast-Forward to Next Class,
Decision Time at General Motors R*Works
• Meet Vince O’Brien, VP-Regional Managing
Director for General Motors R*Works
• R*Works: regional promotional agency for GM;
manages partnerships with sports organizations
• The decision: How to get dealers to support
R*Works ski mountain promotional
partnerships?
53