Importance of Pricing and Pricing Objectives

1. CHAPTER FIFTEEN $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ PRICING CONCEPTS Prepared by Jack Gifford Miami University (Ohio) 2001 South-Western College Publishing

2. To the consumer… The cost of something In the broadest sense, price allocates resources in a free-market economy To the marketer… Price is revenue, source of profit IMPORTANCE OF PRICING 2001 South-Western College Publishing

3. Is that which is given up in an exchange to acquire a good or service Can relate to anything with perceived value Facilitates the exchange process Is the medium of exchange An agreed upon abstraction based upon supply and demand and value assessment Has many names: Revenue Rent Fee Donation Toll Honorarium Tuition WHAT IS A PRICE? 2001 South-Western College Publishing

4. IMPORTANCE OF PRICE TO MARKETING MANAGERS • Revenue is the price charged to customers multiplied by the number of units sold • Revenue is what pays for every activity of a company • Profit is what’s left over after paying for all these activities • Marketers must select a price that is not too high or not too low, a price that equals the perceived value to target consumers 2001 South-Western College Publishing

5. PRICING OBJECTIVES • . PROFIT MAXIMIZATION • Setting prices so that total revenue is as large as possible relative to total costs • Competitive environment? • Highest price possible given consumers perceived value of the product • Profit-oriented pricing objectives • Sales-oriented pricing objectives • Status quo pricing objectives 2001 South-Western College Publishing

6. PRICING OBJECTIVES • . SATISFACTORY PROFITS • Setting prices so that profits to stakeholders are satisfactory • What is satisfactory depends upon levels of risk and management objectives • Profit-oriented pricing objectives • Sales-oriented pricing objectives • Status quo pricing objectives 2001 South-Western College Publishing

7. PRICING OBJECTIVES • . TARGET RETURN ON INVESTMENT (ROI) • ROI = NPat / TA • If you think of your savings account, it is the interest you earn on your money; the more the better • A “good” ROI depends upon the level of risk, industry benchmarks, and available alternatives • Profit-oriented pricing objectives • Sales-oriented pricing objectives • Status quo pricing objectives 2001 South-Western College Publishing

8. PRICING OBJECTIVES • . Market share: A percentage of sales for that industry • Sales can be reported in either dollars or units • Profitability and high market share are often highly correlated..but not always • . Sales Maximization • Profit-oriented pricing objectives • Sales-oriented pricing objectives • Status quo pricing objectives 2001 South-Western College Publishing

9. PRICING OBJECTIVES • Profit-oriented pricing objectives • Sales-oriented pricing objectives • Status quo pricing objectives • . Seeks to maintain existing prices or meet the competition’s prices • Price leadership • Minimizes price wars 2001 South-Western College Publishing

10. PRICE IN THE ECONOMY • The Demand Curve: • Demand is the quantity of a product consumers are willing and able to buy at a given price. Normally, the higher the price, the lower the demand. • As prices drop, consumers will be willing to purchase more of an item • The slope of the demand line depends upon the sensitivity of demand to prices Price Demand 2$ 1$ Quantity One unit Two units 2001 South-Western College Publishing

11. ELASTICITY OF DEMAND • Price elasticity measures the percentage change in quantity demanded by a percentage change in price. • Elastic • Inelastic • Unitary elasticity % CHANGE IN QUANTITY DEMANDED OF GOOD “A” E = % CHANGE IN PRICE OF GOOD “A” 2001 South-Western College Publishing

12. ELASTICITY OF DEMAND: INELASTIC • Relatively Inelastic Price Demand A relatively large increase in price results in only a small decrease in quantity demanded. Quantity E is less than 1.0 2001 South-Western College Publishing

13. ELASTICITY OF DEMAND: ELASTIC • Relatively Elastic Price Demand A relatively small decrease in price results in a substantial increase in quantity demanded. Quantity E is greater than 1.0 2001 South-Western College Publishing

14. FACTORS THAT AFFECT ELASTICITY • Availability of substitutes • Price relative to purchasing power • Product durability • A product’s other uses 2001 South-Western College Publishing

15. THE COST DETERMINANT OF PRICE • All costs are Fixed, Variable, or a combination of fixed and variable • The costs and revenues associated with the production of “one more unit” of a product are called marginal costs and marginal revenues • An analysis of these and other costs help marketers determine alternative pricing strategies 2001 South-Western College Publishing

16. ALTERNATIVE METHODS OF COST BASED PRICING • Markup pricing • Formula pricing (keystoning) • Profit maximization pricing • Break-even pricing • Target-return pricing 2001 South-Western College Publishing

17. Stage in the product life cycle Introductory Growth Maturity Decline High or low pricing Prices begin to stabilize and drop Prices drop dramatically Lowest prices; little if any profits; prices may be below costs OTHER DETERMINANTS OF PRICE 2001 South-Western College Publishing

18. OTHER DETERMINANTS OF PRICE • The competition • Distribution strategy • Promotion strategy • The relationship of price to quality • Demands of larger customers • Global environmental influences 2001 South-Western College Publishing

19. HOW TO SET A PRICE ON A PRODUCT • Setting the right price on a product is a four-step process: • Establish pricing goals • Estimate demand, costs, and profits • Choose a price strategy to help determine a base price • Fine tune the base price with pricing tactics 2001 South-Western College Publishing

20. SETTING A PRICE ON A PRODUCT:Establishing pricing goals • Select profit-oriented, sales-oriented, or status quo, as discussed in the prior chapter • Must study the competition to determine reasonableness of pricing goals • Determine market share necessary to achieve desired pricing goals • All pricing goals have trade-offs 2001 South-Western College Publishing

21. SETTING A PRICE ON A PRODUCT:Estimate demand, costs, and profits • Revenue is a function of price and quantity demanded • Quantity demanded depends upon elasticity • Therefore, marketers must estimate the profit that can be generated at various prices, given demand, elasticity and costs. $1.35 ? $1.49 ? 2001 South-Western College Publishing

22. SETTING A PRICE ON A PRODUCT:Choose a price strategy • The basic, long-term pricing framework for a good or service should be a logical extension of the pricing objectives. • Must determine initial price and price points over time as the product moves through the product life cycle • Must be set to provide a perceived value for a defined target market 2001 South-Western College Publishing

23. Three basic strategies include… Price skimming Penetration pricing Status quo pricing Price higher than those of competitors Used when a product or service has a unique advantage Used when demand exceeds supply in the short run May take advantage of legal protection against competition (patents) To create a prestige image SETTING A PRICE ON A PRODUCT:Choose a price strategy 2001 South-Western College Publishing

24. SETTING A PRICE ON A PRODUCT:Choose a price strategy • The basic, long-term pricing framework for a good or service should be a logical extension of the pricing objectives. • Must determine initial price and price points over time as the product moves through the product life cycle • Must be set to provide a perceived value for a defined target market 2001 South-Western College Publishing

25. Three basic strategies include… Price skimming Penetration pricing Status quo pricing Set price lower than competition A means to reach the mass market Designed to capture a large market share Lower prices usually mean higher break-even-points Effective in a price-sensitive market SETTING A PRICE ON A PRODUCT:Choose a price strategy Southwest Airlines strategy 2001 South-Western College Publishing

26. THE LEGALITY AND ETHICS OF PRICE STRATEGY • Some price decisions are subject to government regulation designed to stimulate full disclosure, prevent monopolies, and stimulate the free market enterprise system MAYBE YES NO 2001 South-Western College Publishing

27. THE LEGALITY AND ETHICS OF PRICE STRATEGY • Unfair Trade Practices • Exist in about 1/2 of the states in the USA • Selling below cost is illegal • Wholesalers and retailers must have a minimum markup of ….. (depends upon state) • Designed to protect small competitors 2001 South-Western College Publishing

28. THE LEGALITY AND ETHICS OF PRICE STRATEGY • Price fixing • An agreement between two or more firms on the price they will charge for a product or service. • Illegal under the Sherman Act and the Federal Trade Commission Act • Can result in both fines and jail sentences! If we both charge $40 per dozen units and share the market 50/50, we will both come out ahead. 2001 South-Western College Publishing

29. Price discrimination Sellers must offer substantially identical goods to different parties for the same price and terms if the situations are materially the same Only relates to interstate trade Must be carried out in a short period of time Products must be of like grade and and quality The charging of different prices must result in a significant competitive injury COMMON DEFENSES BY SELLERS INCLUDE... THE LEGALITY AND ETHICS OF PRICE STRATEGY 2001 South-Western College Publishing

30. THE LEGALITY AND ETHICS OF PRICE STRATEGY • A seller MAY charge different prices even in the above named situations IF… • The price differential is justified by different manufacturing costs or quantity discount savings • In good faith to meet changing market conditions • To meet the prices of competition These exceptions provide lots of “weasel room” for marketers! 2001 South-Western College Publishing

31. THE LEGALITY AND ETHICS OF PRICE STRATEGY • Predatory pricing • Is the practice of charging a very low price for a product with the INTENT of driving competitors out of business or out of a market • Illegal under the Federal Trade Commission Act • Must prove both intent and sale below average cost to prosecute 2001 South-Western College Publishing

32. TACTICS FOR FINE TUNING THE BASE PRICE • Discounts, Allowances, Rebates and Value Pricing • Quantity discounts • Cash discounts • Functional discounts • Seasonal discounts • Promotional discounts • Rebates • Value based pricing (trade loading) Price = X -QD -CD -FD ------------- Net price 2001 South-Western College Publishing

33. TACTICS FOR FINE TUNING THE BASE PRICE • Geographic pricing • FOB, origin pricing • Uniform delivered pricing • Zone pricing • Freight absorption pricing • Basing-point pricing 2001 South-Western College Publishing

34. TACTICS FOR FINE TUNING THE BASE PRICE • Special pricing tactics • Single-price tactic • Flexible or variable pricing (cars) • Professional services pricing • Price lining • Leader or loss leader pricing • Odd-even pricing • Price bundling • Two-part pricing For you the price is $19.95 2001 South-Western College Publishing