978-0136074892 Solution Manual Chapter 09 Part 1

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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

·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.