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LEARNING OBJECTIVES
In this chapter, we will address the following questions:
1. How do consumers process and evaluate prices?
2. How should a company set prices initially for products or services?
3. How should a company adapt prices to meet varying circumstances and
opportunities?
4. When and how should a company initiate a price change?
5. How should a company respond to a competitor’s price change?
CHAPTER SUMMARY
1. Price is the only marketing element that produces revenue; the others produce
costs. Pricing decisions have become more challenging in a changing economic and
technological environment.
2. In setting pricing policy, a company follows a six-step procedure. It selects its
pricing objective. It estimates the demand curve, the probable quantities it will sell at
each possible price. It estimates how its costs vary at different levels of output, at
different levels of accumulated production experience, and for differentiated marketing
offers. It examines competitors’ costs, prices, and offers. It selects a pricing method, and
it selects the final price.
3. Companies usually set a pricing structure that reflects variations in geographical
demand and costs, market-segment requirements, purchase timing, order levels, and other
factors. Several price-adaptation strategies are available: (1) geographical pricing, (2)
price discounts and allowances, (3) promotional pricing, and (4) discriminatory pricing.
4. A price decrease might be brought about by excess plant capacity, declining
market share, a desire to dominate the market through lower costs, or economic
recession. A price increase might be brought about by cost inflation or overdemand.
Companies must carefully manage customer perceptions when raising prices.
5. Companies must anticipate competitor price changes and prepare contingent
responses, including maintaining or changing price or quality.
6. The firm facing a competitor’s price change must try to understand the
competitor’s intent and the likely duration of the change. A market leader attacked by
lower-priced competitors can seek to better differentiate itself, introduce its own low-cost
competitor, or transform itself more completely.
C H A P T E
R 1
6
DEVELOPING PRICING
STRATEGIES AND
PROGRAMS
OPENING THOUGHT
Students should have a good understanding of “price” in their role as consumers. The
instructor is encouraged to expand the student’s definition of “a price” by using examples
of different pricing structures (cell phone plans for example), promotional pricing,
geographical pricing, and price discrimination.
An area for some misunderstanding for students new to marketing is how the firm
reviews competitor’s reactions to price changes. Students will have some degree of
difficulty in assuming the “role” of a competitor and formulating defensive and/or
offensive plans to price changes. Sufficient classroom time should be spent in clarifying
these roles.
Discriminatory pricing is also an area that students new to marketing can have some
difficulty understanding for the first time. Although discriminatory pricing is not illegal,
per se, the distinctions are sometimes porous between the two.
TEACHING STRATEGY AND CLASS ORGANIZATION
PROJECTS
1. At this point in the semester-long marketing plan project, students should be prepared
to hand in their pricing strategy decisions for their fictional product/service. In
reviewing this section, the instructor should make sure that the students have
addressed all or most of the material concerning pricing covered in this chapter.
2. Consumer perceptions of prices are also affected by alternative pricing strategies.
Marriott Hotels, for example, has different brands for differing price points. Building
upon the Marriott example, students are to scan the environment to find examples of a
company whose pricing strategy is closely tied to its branding strategy. Caution:
students may want to list just the different price points in the same company such as
Ford automobiles. What this project is designed to accomplish, is that students should
note that the Lincoln line of cars are priced at a premium to the Ford and Mercury
divisions. Good students will also have researched the actual percentage difference
between the three divisions.
3. Sonic PDA Marketing Plan: Pricing is a critical element in any company’s marketing
plan, because it directly affects revenue and profit goals. Effective pricing strategies
must consider costs as well as customer perceptions and competitor reactions,
especially in highly competitive markets.
You are in charge of pricing Sonic’s first PDA. Review your SWOT Analysis and
Competition Analysis. Also, think about the markets you are targeting and the
positioning you want to achieve. Then, answer the following questions about pricing:
What should Sonic’s primary pricing objective be? Why?
Are PDA customers likely to be price-sensitive? Is demand elastic or inelastic?
What are the implications of the answers for pricing decisions?
What price adaptations such as discounts, allowances, and promotional pricing
should Sonic include in its marketing plan?
Document your pricing strategies and programs in a written marketing plan or type them
into the Marketing Mix section of Marketing Plan Pro.
ASSIGNMENTS
Marketers recognize that consumers often actively process price information, interpreting
prices in terms of their knowledge from prior purchasing experience, formal
communications, informal communications, point-of-purchase, or online resources.
Purchase decisions are based on how consumers perceive prices and what they consider
to be the current actual price—not the marketer’s stated price. In small groups, ask the
students to choose a service good, such as education, legal advice, tax advice, or other
such services, and have them map out their perception of prices and what they consider to
be the current actual price. Finally, students should compare and contrast their
perceptions with the stated or published prices for these services. In completing this
assignment, students should explain the differences between perception and stated prices
in terms of consumer buying behavior models from Chapter 6 of this text.
Many consumers use price as an indicator or quality. As a group assignment, students
should choose a product produced by a firm. Subsequently, the students should conduct a
small research project (utilizing the material learned from Chapter 4) and either, confirm,
or deny this relationship for the chosen product. For example, do more women or men
rely on price as an indicator of quality for product X? If there is a difference, what is the
quantifiable difference in terms of marketing research data? Does this difference suggest
that marketers must or can revise, or revamp price clues to reach their target market?
Katherine Heires in Business Week 2.0, October 2006, wrote “Why it Pays to Give Away
the Store.” Either in small groups or individually, have the students read Ms. Heires
article and comment on the validity/invalidity of these nine suggestions as being
applicable to key service companies.
Table 16.1 lists some possible consumer reference prices and students should comment
on whether or not these consumer reference prices are applicable today. Is this list
inclusive or are there new reference points caused by the increased use of such Web sites
like eBay or Craigslist?
Table 16.3 lists nine factors that the authors contend leads to less price sensitivity in
consumers. Choose a product that is available online and in stores (books or tires, for
example) and ask the students to research the various pricings choices available online.
After collecting this data, ask the students to comment on whether or not, the variety of
price points found lowers their price sensitivity?
For many firms pricing is the domain of the financial disciplines in the company. Using
accepted accounting and financial processes, some companies’ price strictly according to
these models. Assign students the assumed role of “defenders” of this practice and others
as “innovators,” challenging these models and supporting some of the newer pricing
models such as “perceived” and “value” pricing for products. Have the students come
prepared to defend their positions using the concepts developed in this chapter.
Paul W. Farris and David J. Reibstein, in their article, “How Prices, Expenditures, and
Profits Are Linked,” Harvard Business Review (November-December 1979); pp.
173-184, found a relationship between relative price, relative quality, and relative
advertising (their findings are summarized in the chapter). Students should read the full
report, and then be prepared to discuss the validity of this study in light of the consumer
information explosion that has occurred due to the emergence of the Internet. Are these
relationships still valid today? If not, why or what has caused them to change?
DETAILED CHAPTER OUTLINE
Opening vignette: Price is the one element of the marketing mix that produces revenue;
the other elements produce costs. Price also communicates the company’s intended value
positioning of its product or brand. A well-designed and marketed product can still
command a price premium and reap big profits. But new economic realities have caused
many consumers to reevaluate what they are willing to pay for products and services, and
companies have had to carefully review their pricing strategies as a result.
Pricing decisions are complex and must take into account many factors—the company,
the customers, the competition, and the marketing environment. Holistic marketers know
their pricing decisions must also be consistent with the firm’s marketing strategy and its
target markets and brand positions.
I. Understanding Pricing
A. Price comes in many forms and performs many functions.
B. Price also has many components.
C. Pricing in a Digital World
i. Price has operated as a major determinant of buyer choice.
1. Consumers and purchasing agents who have access to price
information and price discounters put pressure on retailers to
lower their prices
2. Retailers put pressure on manufacturers to lower their prices.
3. The result can be a marketplace characterized by heavy
discounting and sales promotion.
ii. Downward price pressure from a changing economic environment
coincided with some longer-term trends in the technological
environment.
iii. Buyers can:
1. Get instant price comparisons from thousands of vendors.
2. Check prices at the point of purchase
3. Name their price and have it met
4. Get products free
iv. Sellers can:
1. Monitor customer behavior and tailor offers to individuals.
2. Give certain customers access to special prices.
v. Both buyers and sellers can negotiate prices in online auctions and
exchanges or even in person.
D. A Changing Pricing Environment is a result of the recession and the resource
constrained Millennial cohort.
i. Result = sharing economy in which consumers share bikes, cars,
clothes, couches, apartments, tools, and skills and extracting more
value from what they already own.
ii. Bartering, one of the oldest ways of acquiring goods, is making a
comeback through transactions estimated to total $12 billion annually
in the United States.
iii. The sector of the new sharing economy that is really exploding is
rentals.
E. How Companies Price
i. Bosses or top management sets general pricing objectives and policies
and often approves lower management’s proposals.
ii. Many companies do not handle pricing well and fall back on
“strategies” such as: “We calculate our costs and add our industry’s
traditional margins.”
iii. Other common mistakes are not revising price often enough to
capitalize on market changes; setting price independently of the rest of
the marketing program rather than as an intrinsic element of
market-positioning strategy; and not varying price enough for different
product items, market segments, distribution channels, and purchase
occasions.
iv. For any organization, effectively designing and implementing pricing
strategies requires a thorough understanding of consumer pricing
psychology and a systematic approach to setting, adapting, and
changing prices.
F. Consumer Psychology and Pricing
i. Consumers often actively process price information, interpreting it
from the context of prior purchasing experience, formal
communications (advertising, sales calls, and brochures), informal
communications (friends, colleagues, or family members),
point-of-purchase or online resources, and other factors.
ii. Purchase decisions are based on how consumers perceive prices and
what they consider the current actual price to be—not on the
marketer’s stated price.
iii. Understanding how consumers arrive at their perceptions of prices is
an important marketing priority.
II. Reference Prices
A. Few consumers can accurately recall specific prices
B. Consumers often employ reference prices, comparing an observed price to an
internal reference price they remember or an external frame of reference such
as a posted “regular retail price.”
i. “Fair Price” (what consumers feel the product should cost)
ii. Typical Price
iii. Last Price Paid
iv. Upper-Bound Price (reservation price or the maximum most
consumers would pay)
v. Lower-Bound Price (lower threshold price or the minimum most
consumers would pay)
vi. Historical Competitor Prices
vii. Expected Future Price
viii. Usual Discounted Price
III. Price-Quality Inferences
A. Many consumers use price as an indicator of quality.
i. Image pricing is especially effective with ego-sensitive products such
as perfumes, expensive cars, and designer clothing.
ii. When information about true quality is available, price becomes a less
significant indicator of quality.
B. Exclusivity and scarcity can also affect quality inferences
IV. Price Endings
A. Consumers tend to process prices “left to right” rather than by rounding
B. Another explanation for the popularity of “9” endings is that they suggest a
discount or bargain, so if a company wants a high-price image, it should
probably avoid the odd-ending tactic.
C. Prices that end with 0 and 5 are also popular and are thought to be easier for
consumers to process and retrieve from memory.
D. Total category sales are highest when some, but not all, items in a category
have sale signs; past a certain point, sale signs may cause total category sales
to fall.
E. Pricing cues such as sale signs and prices that end in 9 are more influential
when consumers’ price knowledge is poor, when they purchase the item
infrequently or are new to the category, and when product designs vary over
time, prices vary seasonally, or quality or sizes vary across stores.
V. Setting the Price
A. The firm must decide where to position its product on quality and price.
B. Having a range of price points allows a firm to cover more of the market and
to give any one consumer more choices.
C. New Luxury Products
i. Accessible super-premium products
ii. Old Luxury brand extensions
iii. Masstige goods
iv. Consumers often “trade down” by shopping at discounters such as
Walmart and Costco for staple items or goods that confer no emotional
benefit but still deliver quality and functionality.
D. Steps in Setting a Pricing Policy: Step One—Selecting the Pricing Objective
i. Five major objectives are: survival, maximum current profit,
maximum market share, maximum market skimming, and
product-quality leadership.
ii. Companies pursue survival as their major objective if they are plagued
with overcapacity, intense competition, or changing consumer wants.
iii. Many companies try to set a price that will maximize current profits.
iv. Some companies want to maximize their market share/use
market-penetration pricing
1. The market is highly price sensitive and a low price stimulates
market growth
2. Production and distribution costs fall with accumulated
production experience
3. Low price discourages actual and potential competition.
v. Companies unveiling a new technology favor setting high prices to
maximize market skimming (prices start high and slowly drop over
time).
1. Fatal if a worthy competitor decides to price low.
2. Consumers who buy early at the highest prices may be
dissatisfied if they compare themselves with those who buy
later at a lower price.
3. A sufficient number of buyers have a high current demand
4. The unit costs of producing a small volume are high enough to
cancel the advantage of charging what the traffic will bear
5. The high initial price does not attract more competitors to the
market
6. The high price communicates the image of a superior product.
vi. A company might aim to be the product-quality leader in the market
vii. Nonprofit and public organizations may have other pricing objectives.
E. Steps in Setting a Pricing Policy: Step Two—Determining Demand
i. Each price will lead to a different level of demand and have a different
impact on a company’s marketing objectives.
ii. The normally inverse relationship between price and demand is
captured in a demand curve: The higher the price, the lower the
demand.
iii. The first step in estimating demand is to understand what affects price
sensitivity.
1. Generally speaking, customers are less price sensitive to
low-cost items or items they buy infrequently.
2. They are also less price sensitive when (1) there are few or no
substitutes or competitors; (2) they do not readily notice the
higher price; (3) they are slow to change their buying habits;
(4) they think the higher prices are justified; and (5) price is
only a small part of the total cost of obtaining, operating, and
servicing the product over its lifetime.
iv. A seller can successfully charge a higher price than competitors if it
can convince customers that it offers the lowest total cost of ownership
(TCO).
v. Factors that Reduce Price Sensitivity
1. Distinctive product, low awareness of substitutes, hard to
compare to substitutes, small relative to income or total cost of
end product, someone else is paying
2. Product used in conjunction with assets previous bought, more
quality, prestige and exclusiveness assumed, buyers cannot
store the product.
vi. Most companies attempt to measure their demand curves using several
different methods.
1. Surveys can explore how many units consumers would buy at
different proposed prices.
2. Price experiments can vary the prices of different products in a
store or of the same product in similar territories to see how the
change affects sales.
3. Statistical analysis of past prices, quantities sold, and other
factors can reveal their relationships.
4. In measuring the price-demand relationship, the market
researcher must control for various factors that will influence
demand
vii. Marketers need to know how responsive, or elastic, demand is to a
change in price.
1. If demand hardly changes with a small change in price, we say
it is inelastic.
2. If demand changes considerably, it is elastic.
3. The higher the elasticity, the greater the volume growth
resulting from a 1 percent price reduction.
4. Long-run price elasticity may differ from short-run elasticity.
F. Steps in Setting a Pricing Policy: Step Three—Estimating Costs
i. Demand sets a ceiling on the price the company can charge for its
product. Costs set the floor.
ii. A company’s costs take two forms, fixed and variable.
1. Fixed costs, or overhead, are costs that do not vary with
production level or sales revenue.
2. Variable costs vary directly with the level of production.
3. Total costs consist of the sum of the fixed and variable costs for
any given level of production.
4. Average cost is the cost per unit at that level of production; it
equals total costs divided by production.
iii. Accumulated production reduces costs; the experience curve or
learning curve improves processes
iv. Aggressive pricing might give the product a cheap image or assume
competitors are weak followers.
v. Costs change with production scale and experience. They can also
change as a result of a concentrated effort by designers, engineers, and
purchasing agents to reduce them through target costing.
vi. Cost cutting cannot go so deep as to compromise the brand promise
and value delivered.
G. Steps in Setting a Pricing Policy: Step Four—Analyzing Competitors’ Costs,
Prices and Offers
i. If the competitor’s offer contains some features not offered by the
firm, the firm should subtract their value from its own price.
ii. Companies offering the powerful combination of low price and high
quality are capturing the hearts and wallets of consumers all over the
world
iii. One school of thought is that companies should set up their own
low-cost operations to compete with value-priced competitors only if:
(1) their existing businesses will become more competitive as a result
and (2) the new business will derive some advantages it would not
have gained if independent
H. Steps in Setting a Pricing Policy: Step Five—Selecting a Pricing Method
i. Costs set a floor to the price.
ii. Competitors’ prices and the price of substitutes provide an orienting
point.
iii. Customers’ assessment of unique features establishes the price ceiling.
iv. Price-setting methods: markup pricing, target-return pricing,
perceived-value pricing, value pricing, EDLP, going-rate pricing, and
auction-type pricing.
VI. Adapting the Price
A. Companies develop a pricing structure that reflects variations in geographical
demand and costs, market-segment requirements, purchase timing, order
levels, delivery frequency, guarantees, service contracts, and other factors.
B. As a result of discounts, allowances, and promotional support, a company
rarely realizes the same profit from each unit of a product that it sells.
C. Price-adaptation strategies include: geographical pricing, price discounts and
allowances, promotional pricing, and differentiated pricing.
D. Price discrimination occurs when a company sells a product or service at two
or more prices that do not reflect a proportional difference in costs.
i. In first-degree price discrimination, the seller charges a separate price
to each customer depending on the intensity of his or her demand.
ii. In second-degree price discrimination, the seller charges less to buyers
of larger volumes.
iii. In third-degree price discrimination, the seller charges different
amounts to different classes of buyers
1. Customer-segment pricing
2. Product-form pricing
3. Image pricing
4. Channel pricing
5. Location pricing
6. Time pricing
iv. Yield pricing offers discounted but limited early purchases,
higher-priced late purchases, and the lowest rates on unsold inventory
just before it expires.
v. Constant price variation can be tricky, however, where consumer
relationships are concerned.
VII. Initiating and Responding to Price Changes
A. Initiating Price Cuts
a. One is excess plant capacity: The firm needs additional business and
cannot generate it through increased sales effort, product improvement, or
other measures.
b. Companies sometimes initiate price cuts in a drive to dominate the market
through lower costs.
c. Either the company starts with lower costs than its competitors, or it
initiates price cuts in the hope of gaining market share and lower costs.
B. A price-cutting strategy can lead to other possible traps:
a. Low-quality trap. Consumers assume quality is low.
b. Fragile-market-share trap. A low price buys market share but not market
loyalty. The same customers will shift to any lower-priced firm that comes
along.
c. Shallow-pockets trap. Higher-priced competitors match the lower prices
but have longer staying power because of deeper cash reserves.
d. Price-war trap. Competitors respond by lowering their prices even more,
triggering a price war
C. Initiating Price Increases
a. A successful price increase can raise profits considerably.
b. Cost inflation and overdemand can provoke price increases.
c. Delayed quotation pricing. The company does not set a final price until the
product is finished or delivered.
d. Escalator clauses. The company requires the customer to pay today’s price
plus all or part of any inflation increase that takes place before delivery.
e. Unbundling. The company maintains its price but removes or prices
separately one or more elements that were formerly part of the offer, such
as delivery or installation.
f. Reduction of discounts. The company instructs its sales force not to offer
its normal cash and quantity discounts.
D. Anticipating Competitive Responses
a. Introduction or change of any price can provoke a response from
customers, competitors, distributors, suppliers, and even government.
b. Competitors are most likely to react when the number of firms is few, the
product is homogeneous, and buyers are highly informed.
E. Responding to Competitors’ Price Changes
a. Why did the competitor change the price? To steal the market, to utilize
excess capacity, to meet changing cost conditions, or to lead an
industry-wide price change?
b. Does the competitor plan to make the price change temporary or
permanent?
c. What will happen to the company’s market share and profits if it does not
respond? Are other companies going to respond?
d. What are the competitors’ and other firms’ likely responses to each
possible reaction?
e. Three possible responses to low-cost competitors are:
i. Further differentiate the product or service
ii. Introduce a low-cost venture
iii. Reinvent as a low-cost player
f. An extended analysis of alternatives may not always be feasible when the
attack occurs.
