Chapter 14 Pricing Concepts for Establishing Value PDF

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Professor: Victor Piscitello...

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Chapter 14

MKTG 361

Book Notes

Pricing Concepts for Establishing Value KEY TERMS Price: The overall sacrifice a consumer is willing to make — money, time, energy — to acquire a specific product or service Profit Orientation: A company objective that can be implemented by focusing on target profit pricing, maximizing profits, or target return pricing Target Profit Pricing: A pricing strategy implemented by firms when they have a particular profit goal as their overriding concern; uses price to stimulate a certain level of sales at a certain profit per unit Maximizing Profits: A profit strategy that relies primarily on economic theory. If a firm can accurately specify a mathematical model that captures all the factors required to explain and predict sales and profits, it should be able to identify the price at which its profits are maximized Target Return Pricing: A pricing strategy implemented by firms less concerned with the absolute level of profits and more interested in the rate at which their profits are generated relative to their investments; designed to produce a specific return on investment, usually expressed as a percentage of sales Sales Orientation: A company objective based on the belief that increasing sales will help the firm more than will increasing profits Premium Pricing: A competitor-based pricing method by which the firm deliberately prices a product above the prices set for competing products to capture those consumers who always shop for the best or for whom price does not matter Competitor Orientation: A company objective based on the premise that the firm should measure itself primarily against its competition Competitive Parity: A firm’s strategy of setting prices that are similar to those of major competitors Status Quo Pricing: A competitor-oriented strategy in which a firm changes prices only to meet those of competition Customer Orientation: A company objective based on the premise that the firm should measure itself primarily according to whether it meets its customers’ needs

Chapter 14

MKTG 361

Book Notes

Demand Curve: Shows how many units of a product or service consumers will demand during a specific period at different prices Prestige Products or Services: Those that consumers purchase for status rather than functionality Price Elasticity of Demand: Measures how changes in a price effect the quantity of the product demanded; specifically the ratio of the percentage change in quantity demanded to the percentage change in price Elastic: Refers to a market for a product or service that is price sensitive; that is, relatively small changes in price will generate fairly large changes in the quantity demanded Inelastic: Refers to a market for a product or service that is price insensitive; that is, relatively small changes in price will generate fairly small changes in the quantity demand Dynamic Pricing: Refers to the process of charging different prices for goods or services based on the type of customer, time of day, week, or even season, and level of demand Individualized Pricing: (SAME AS DYNAMIC PRICING) Income Effect: Refers to the change in the quantity of a product demanded by consumers due to a change in their income Substitution Effect: Refers to a consumer’s ability to substitute other products for the focal brand, thus increasing the price elasticity of demand for the focal brand Cross-Price Elasticity: The percentage change in demand for Product A that occurs to a response to a percentage change in price of Product B Complementary Products: Products whose demand curves are positively related, such that they rise or fall together; a percentage increase in demand for one results in a percentage increase in demand for the other Substitute Products: Products for which changes in demand are negatively related; that is, a percentage increase in the quantity demanded for Product A results in a percentage decrease in the quantity demanded for Product B Variable Costs: Those costs, primarily labor and materials, that vary with production volume Fixed Costs: Those costs that remain essentially at the same level, regardless of any changes in the volume of production

Chapter 14

MKTG 361

Book Notes

Total Cost: The sum of the variable and fixed costs Break-Even Analysis: Technique used to examine the relationships among cost, price, revenue, and profit over different levels of production and sales to determine the break-even point Break-Even Point: The point at which the number of units sold generates just enough revenue to equal the total costs; at this point, profits are zero Contribution Per Unit: Equals the price less the variable cost per unit. Variable used to determine the break-even point in units Monopoly: One firm provides the product or service in a particular industry Oligopolistic Competition: Occurs when only a few firms dominate a market Price War: Occurs when two or more firms compete primarily by lowering their prices Predatory Pricing: A firm’s practice of setting a very low price for one or more of its products with the intent to drive its competition out of business; illegal under both the Sherman Anti-Trust Act and the Federal Trade Commission Act Monopolistic Competition: Occurs when there are many firms that sell closely related but not homogeneous products; these products may be viewed as substitutes but are not perfect substitutes Pure Competition: Occurs when different companies sell commodity products that consumers perceive as substitutable; price usually is set according to the laws of supply and demand Gray Market: Employs irregular but no necessarily illegal methods; generally, it legally circumvents authorized channels of distribution to sell goods at prices lower than those intended by the manufacturer QUIZ-YOURSELF QUESTIONS Q: Marketers can deliver high value through high or low prices, depending on _______________. A: Q: Ferrari and Lamborghini are manufacturers of very expensive automobiles. Their limited edition cars often sell for $300,000 or more. For most consumers, these are prestige products, and demand is likely to be _______________. A:

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Book Notes

THE FIVE Cs OF PRICING o Overview  A good pricing strategy today may not be tomorrow  Price: The overall sacrifice a consumer is willing to make to acquire a specific product or service  Includes money to be paid to the seller  Other monetary sacrifices:  Travel costs, taxes, shipping costs, etc.  Nonmonetary sacrifices:  Value of the time used  Price is one of the most important factors to consumers in purchasing decisions  Price is the most challenging of the four Ps to manage o The Five Cs of Pricing  Competition  Costs  Company objectives  Customers  Channel members o Company Objectives  Different firms = different goals  Goals should spill down to the pricing strategy  Pricing should support and allow the firm to reach its overall goals  Profit Orientation  Focus options:  Target profit pricing o Have a particular profit goal as overriding concern o Use price to stimulate a certain level of sales at a certain profit/unit  Maximizing profits o Relies on economic theory o Explaining and predicting sales and profits should mean you can identify profit-maximizing price o Problem: Actually gathering data and developing an accurate mathematical model is difficult  Target return pricing o Less concern with absolute level of profits; more interested in rate at which profits are generated relative to their investments o Employ pricing strategies designed to produce a specific ROI, usually a % of sales  Sales Orientation  1. Believe that increasing sales will help the firm more than increasing profits  2. Believe that overall market share is more important

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Book Notes

To gain market share, a firm may set low prices to: o Discourage new firms from entering the market o Encourage current firms to leave the market o Take market share away from competitors  Premium Pricing  The firm deliberately prices above competitors o For consumers who search for the best or do not care about price  Must have a quality product/service so the price is perceived as fair  Competitor Orientation  Firms strategize according to the premise that they should measure themselves primarily against their competition  Competitive Parity  Set prices that are similar to major competitors’  Status Quo Pricing  Change prices only to meet those of the competition  Customer Orientation  Firm sets its pricing strategy based on how it can add value to its products or services  Should set prices with a close eye to how consumers develop their perceptions of value o Customers  When firms have developed their company objectives, they turn to understanding consumers’ reactions to different prices  Customers want value, and price if half of the value equation  Demand Curves and Pricing  The Demand Curve  Prestige Products or Services  Consumers purchase for their status rather than their functionality  Higher price = greater status and greater exclusivity  Fewer people can afford to purchase it  Price Elasticity of Demand  The ratio of the percentage change in quantity demanded to the percentage change in price  Elastic vs. Inelastic  Usually changes at different points in the demand curve unless the curve is actually a straight line  Dynamic Pricing or Individualized Pricing  Charge different prices based on:  Type of customer  Time of day, week or season  Level of demand  Loyalty status

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Book Notes

Factors Influencing Price Elasticity of Demand  Income Effect  Change in quantity demanded due to change in income  More income = demand higher-priced alternatives  More income = purchase more  Substitution Effect  Consumer ability to substitute other products for the focal brand  More substitutes = higher elasticity of demand Cross-Price Elasticity   % Change in the quantity of Product A demanded compared with the % change in price in Product B o If Product A’s price increased, Product B could either increase or decrease, depending on the situation and whether the products are complementary or substitutes  Complementary Products o Demands are positively related  Substitute Products o Demands are negatively related

o Costs  Variable Costs  Vary with production volume  E.g. labor and materials  Generally expressed on a per-unit basis  Can go up or down with significant changes in volume  Fixed Costs  Remain essentially at the same level regardless of volume of production changes  E.g., rent, utilities, insurance, admin salaries, depreciation of physical PPE  Total Cost  VC + FC  Break-Even Analysis and Decision Making  Break-Even Analysis  Break-Even Point  # of units sold generates enough revenue to equal total costs  Profits = 0  Contribution Per Unit  Limitations:  Unlikely to charge one single price for everything  Prices often get reduced as quantity increases because the costs decrease o Must perform several break-even analyses at different quantities  Cannot indicate for sure how many units will see at a given price  Markup and Target Return Pricing

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Book Notes

 Target Return Price = (VC + (FC / Expected Unit Sales)) x (1 + Target return % [expresses as a decimal]) o Competition  Four levels of competition:  Monopoly  Oligopolistic competition  Monopolistic competition  Pure competition  Monopoly  One firm provides the product/service in the industry  Less price competition  Oligopolistic Competition  Only a few firms dominate  Change prices in reaction to competitors  Price War  When two or more firms compete primarily by lowering their prices Predatory Pricing   When a firm sets a very low price for one or more of its products with the intent to drive its competition out of business  Monopolistic Competition  When there are many firms competing for customers in a given market but their products are differentiated  Product differentiation appeals to customers Pure Competition   Large number of sellers offer standardized products or commodities that consumers perceive as substitutable  E.g. grains, gold meet, spices, minerals  Price is set usually according to law of supply and demand

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MKTG 361

Book Notes

o Channel Members  3 Main members:  Manufactures  Wholesalers  Retailers  Channels can be difficult to manage  Distribution outside normal channels occurs  Gray Market  Employs irregular but not necessarily illegal methods; legally circumvents authorized channels of distribution to sell goods at prices lower than those intended by the manufacturer...