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Chapter 9: Pricing
Chapter Objectives
After reading this chapter, students should understand:
·The need for consistency between price and the marketing strategy
·The concept of perceived value and how it is critical to setting price
·Integrating competition and costs into the pricing decision
·Deciding how much of the strategic pricing gap between cost and perceived
value to capture
·Specific pricing tactics such as product line pricing, value pricing, and
competing against private labels
·How the Internet is affecting pricing decisions
Chapter Overview
The purpose of this chapter is to introduce the concepts involved with strategic
price setting.
Chapter Outline and Key Terms
Pricing
Key Terms:
·Customer value
·Price discrimination
·Price bands or tiers
·Reservation price
·Pricing elasticity of demand
·Value-in-use
·Dollarmetric measurement
·Conjoint analysis
·Field experiments
·Penetration pricing
·Market share pricing
·Skimming
·Prestige pricing
Copyright© 2011 Pearson Education, Inc., publishing as Prentice Hall 1
·Return on sales pricing
·Investment pricing
·Competitive pricing
·Reference price
·Price bundling
·Product-line pricing
·Complementary pricing
·Value pricing
·Periodic discounting
·Flat-rate vs. variable rate pricing
A. Definitions
1. Customer value: What a product or service is worth to the customer in
monetary terms; also called perceived value.
2. Price discrimination: the practice of charging different prices to segments of
the market according to their price elasticity or sensitivity.
3. Price bands or tiers: Price variations within a product category.
4. Reservation price: The maximum price someone is willing to pay for a
product or the price at which the product is eliminated from the customer’s
budget.
5. Price elasticity of demand: The percentage change in a product’s demand
resulting from a 1% change in the price.
6. Value-in-use: A method of estimating customer value that puts the benefits
of the product in monetary terms, such as time savings, less use of materials,
and less downtime.
7. Dollarmetric method: In estimating customer value, a method used in
conjunction with survey-based methods that creates a scale that puts survey
responses in monetary terms.
8. Conjoint analysis: A popular marketing research method in new product
development that uses theoretical profiles or concepts to determine how
customers value different levels of product attributes.
9. Field experiments: An experiment that takes place in a realistic
environment.
10. Penetration pricing: Also called market share pricing, a pricing policy
intended to gain as much market share as possible; often used as a part of an
entry strategy for a new product.
11. Market share pricing: Also called penetration pricing, a pricing policy in
which the objective is to gain as much market share as possible; often used
as part of an entry strategy for a new product.
12. Skimming: Also called prestige pricing, a pricing policy used when there is
a strong price-perceived quality relationship and the product is positioned at
the high end of the market; often used when costs are not related to volume
and gaining significant market share is not an objective.
13. Return on sales pricing: Also called investment pricing, a pricing policy that
assumes you can set a price that will deliver the rate of return demanded by
senior management; most often used when a product has a monopoly
position.
14. Investment pricing: Also called return on sales, a pricing policy that
assumes you can set a price that will delivery the rate of return demanded by
senior management: most often used when a product has a monopoly
position.
15. Competitive pricing: A pricing policy in which the objective is to maintain a
competitive price by either pricing at the market average or copying a
particular brand.
16. Reference price: Any standard of comparison against which an observed
potential transaction or purchase price is compared.
17. An approach to product line pricing in which a set of products is offered to
customers in a package, which is usually priced lower than the sum of the
individual components.
18. Product-line pricing: Pricing a pricing strategy covering a set of products.
19. Complementary pricing: An approach to product line pricing that applies to
products that are used together when one of the products is a consumable
that must be replenished.
20. Value pricing: Giving customers more value than they expect for the price
paid.
21. Second market discounting: Selling excess production of a product at a
discount to a market distinct from the main market.
22. Periodic discounting: A pricing strategy that varies price over time in order
to take advantage of particular time periods during which some customers
are willing to pay a higher price.
23. Flat rate versus variable-rate pricing: Strategy often used in services that
offers customers a choice between a fixed price and a variable usage fee.
B. The Role of Marketing Strategy in Pricing
1. Marketing strategy and pricing:
·Design the marketing strategy and then the implementation of this
strategy.
·Pricing must be consistent with the marketing strategy
·Strategy decisions do not lead to specific price-setting rules; rather, they
give general guidelines.
·Target market decision affects price because prices can vary over
segments. (Price discrimination: different prices to different segments
according to price sensitivity or price elasticity.)
·Price variations in product categories are called price bands or tiers.
Figure 9.1 Page 248 Price Tiers in GPS Products Shows some of the
variation of prices in the GPS market
·
C. Perceived Value
1. Factors affecting price:
·Major factor affecting price is the customer’s perceived value.
·No single perceived value in the marketplace
·Perceived value is unique to the customer
·Perceived value is always relative.
·Three key relationships:
·Perceived value > Price > Cost
·Price > Perceived value > Cost
·Price > Cost > Perceived value
2. Perceived value > Price > Cost
·May under price a product for strategic reasons (value pricing)
(Example: Mazda Miata)
·Most cases, prices are set below customer value simply because the
manager does not have enough information.
·In some cases, setting a price below value is not intentional and simple
consumer mania takes over (Nokia 8810 phone)
3. Price > Perceived value > Cost
·Price is set higher than the target market is willing to pay
·Price reductions in response to lower perceived value are common
4. Price > Cost > Perceived Value
·Customer value falls below manufacturing and marketing costs (Yugo)
5. Illustration: Online music (www.apple.com/itunes) Page 251
6. Framework
·Figure 9.3 Page 252 Strategic Pricing Gap Shows the creation of a
strategic pricing gap.
7. Price Elasticity
·Formula for price elasticity of demand is:
E = Percent change in demand/Percent change in price
·Price elasticity is an indirect measure of customer value in that a
manager can determine how close his/her brand is to the customer
value point through planned price experimentation or market
reactions to price changes.
8. Calculating Customer Value
·Not easy to calculate customers’ willingness to pay or customer
value
·Price elasticities give only a hint at how close to or how far you are
from customer value
·Some methods used to obtain more precise estimates are:
·Value-in-use
·Survey-based methods including dollarmetric method Table 9.1
Page 255 Dollametric Creates a scale that puts responses in
monetary terms.
·Field experimental methods Figure 9.5 Page 256 Price Experiment
for a Mobile Phone.
Illustration: Hewlett Packard (www.hp.com) Page 256
Illustration: Rolling Rock Beer (www.rollingrock.com) Page 257
Illustration: Online Price Experiments (www.nap.edu) Page 257
9. Using the Perceived Value Concept
·Marketing managers can use concept of perceived value by
considering a functional relationship among market share, perceived
value, and price.
·The functional relationship is expressed as follows:
Market share = ƒ (Perceived value/Price)
·Perceived value does not mean customer is always looking for
lowest price.
·Note that the numerator and denominator of the market share
function are not independent (for some product categories, perceived
value may be a function of price).
·Table 9.2 Page 258 Profit Impact of Price Cuts Gives an idea of
what happens to profits with a price cut and no volume or cost
change.
·Increasing price may raise perceived quality. Illustration:
Genentech (www.genentech.com) Page 258
D. Competition and Pricing
1. Competitors’ Costs
·Critical to have some estimate of the relative cost positions held by
competitors
·Cost estimates give you some idea of how low some competitors can
price (Assumes no product is priced under variable costs)
·Cost estimates can give some idea of the margins in the category or
industry
·Costs can be estimated in several ways:
·For manufactured products, use reverse engineering to estimate
costs to analyze cost structure
·Use of publicly available data on competitors (10K statements,
annual reports, etc.)
·Possible to understand current costs and forecast future costs by
use of experience curve (See Chapter 2)
·Figure 9.6 Page 260 Market Share versus Price and Cost
Demonstrates the relationship between market share versus price and
costs
·Illustration: SanDisk (www.sandisk.com) Page 260
E. The Role of Costs
1. Problems exist with using costs to set price.
·Using price as a cost-recovery mechanism can lead to a mismatch
between price and customers’ perceptions of value for your product
or service
·Second problem is that the costs may be a function of volume or
capacity
·Using cost increases to justify price increases may generate little
sympathy from customers and even alienate them.
2. There are four different kinds of costs to consider:
·Development costs (expenses involved in bringing a new product to
market)
·Overhead costs (Costs related to general business operations)
·Direct fixed costs (Costs do not vary with sales volume)
·Variable costs (Varying per-unit costs associated with providing the
product or service
F. Deciding How Much of the Strategic Pricing Gap to Capture
1. Figure 9.3 Page 252 Strategic Pricing Gap This figure provides the
conceptual foundation on how much of the customer value to keep or give
away.
2. Figure 9.7 Page 261 Market Share versus Price and Cost This figure
outlines the key factors involved in this decision (how much of the
customer value to keep or give away.)
3. Pricing Objectives
·Pricing policies can accomplish many different objectives for a
product or service such as:
·Penetration pricing or market share pricing
·Skimming or prestige pricing
·Return on sales or investment pricing
·Pricing for stability
·Competitive pricing
·Illustration: Apple iPhone (www.apple.com/iphone) Page 262
4. Psychological aspects of price
·Price is a communications vehicle as well as a revenue generator
·The three key concepts related to psychological aspects of price
are:
·Reference prices
·The price-perceived quality relationship
·Price points
5. Stage of the product life cycle
·The method used to set prices can also change over the life cycle
·Table 9.3 Page 265 DuPont Pricing Over the Product Life
Cycle Illustrates how DuPont approaches pricing with the life
cycle in mind.
·Another way to look at the impact of the product life cycle is
through experience curve pricing Figure 9.8 Experience Curve-
Based Pricing Patterns over the Product Life Cycle Page 267
Shows three different pricing scenarios.
G. Specific Pricing Tactics
1. Product line pricing. Various tactics include:
·Price bundling/unbundling (takes set of related products and
offers them as a package
·Product-line pricing (covers set of related products)
·Complementary pricing (applies to products that are used
together when one of the products is a consumable)
2. Value pricing: Giving customers more value than they expect for the
price paid
3. Differential pricing: Key strategic decision of which customers to
target recognizes that potential customers’ behavior is heterogeneous.
