978-0134292663 Chapter 10 Lecture Notes Part 2

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Chapter 10: Price: What is the Value Proposition Worth?

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p. 306

2.3.1 The Economy

Broad economic trends tend to direct pricing strategies. The

business cycle, inflation, economic growth, and consumer

confidence all help to determine whether one pricing strategy or

another will succeed.

During recessions, consumers grow more price sensitive. Many

firms find it necessary to cut prices to levels at which costs are

covered but the company does not make a profit to keep factories

in operation.

Inflation may give marketers cause to either increase or decrease

prices. First, inflation gets customers used to price increases.

They may remain insensitive to price increases, even when

inflation goes away, allowing marketers to make real price

increases. In periods of recession, inflation may cause marketers

to lower prices and temporarily sacrifice profits in order to

maintain sales levels.

Exhibit:

ForceFlex

Garbage Bag ad

Exhibit: P&G

Pampers

p. 306 2.3.2 The Competition

Marketers try to anticipate how the competition will respond to

their pricing actions. It is not always a good idea to fight the

competition with lower prices. Pricing wars can change

consumers’ perceptions of what is a “fair” price, leaving them

unwilling to buy at previous price levels.

Generally, firms that do business in an oligopoly (in which the

market has few sellers and many buyers) are more likely to adopt

status quo pricing objectives in which the pricing of all

competitors is similar. Avoiding price competition allows all

players in the industry to remain profitable.

Firms in a purely competitive market have little opportunity to

raise or lower prices. Price is directly influenced by supply and

demand.

p. 306 2.3.3 Government Regulation

Governments in the United States and other countries develop two

different types of regulations, which have an effect on pricing.

First, a large number of regulations increase the costs of

production. Regulations for health care, environmental protection,

occupational safety, and highway safety, just to mention a few,

cause the costs of producing many products to increase. Other

regulations of specific industries such as those imposed by the

Food and Drug Administration (FD) on the production of food

and pharmaceuticals increase the costs of developing and

producing those products. In addition, some regulations directly

address prices.

Chapter 10: Price: What is the Value Proposition Worth?

p. 307

2.3.4 Consumer Trends

Consumer trends also can strongly influence prices. Culture and

demographics determine how consumers think and behave and so

these factors have a large impact on all marketing decisions.

2.3.5 The International Environment

The marketing environment often varies widely from country to

country. This can have important consequences in developing

pricing strategies.

p. 308

3. IDENTIFY STRATEGIES AND TACTICS TO PRICE

THE PRODUCT

In modern business, there seldom is any one-and-only,

now-and-forever, and best pricing strategy. Like playing a game

of chess, making pricing moves and countermoves requires

thinking two and three moves ahead.

3.1 Step 5: Choose a Pricing Strategy

The next step in price planning is to choose a pricing strategy.

3.2 Pricing Strategies Based on Cost

Marketing planners often choose cost-based strategies because

they are simple to calculate and relatively risk free. They promise

that the price will at least cover the costs the company incurs in

producing and marketing the product.

Cost-based pricing methods have drawbacks, however. They do

not consider such factors as the nature of the target market,

demand, competition, the product life cycle, and the product’s

image. The calculations for setting the price may be simple and

straightforward but accurate cost estimating may prove difficult.

The most common cost-based approach to pricing a product is

cost-plus pricing in which the marketer totals all the costs for the

product and then adds an amount (or marks up the cost of the

item) to arrive at the selling price. Many marketers use cost-plus

pricing because of its simplicity—users need only estimate the

unit cost and add the markup. To calculate cost-plus pricing,

marketers usually calculate either a markup on cost or a markup

on selling price. Keystoning is a retail pricing strategy in which the

retailer doubles the cost of the item (100 percent markup) to determine

the price.

Figure 10.11

Snapshot: Pricing

Strategies and

Tactics

p. 309 3.2.1 Pricing Strategies Based on Demand

Demand-based pricing means that the firm bases the selling price

on an estimate of volume or quantity that it can sell in different

markets at different prices. Firms must determine how much

Chapter 10: Price: What is the Value Proposition Worth?

p. 309

product they can sell in each market and at what price.

Today, firms find that they can be more successful if they match

price with demand using a target costing process. They first

determine the price at which customers would be willing to buy

the product and then works backward to design the product in

such a way that it can produce and sell the product at a profit.

With target costing, firms first use marketing research to identify

the quality and functionality needed to satisfy attractive market

segments and what price they are willing to pay before the

product is designed. The next step is to determine what margin

retailers and dealers require as well as the profit margin the

company requires. Based on this information, managers can

calculate the target cost—the maximum it will cost the firm to

manufacture the product. If the firm can meet customer quality

and functionality requirements and control costs to meet the

required price, it will manufacture the product.

Yield management pricing, another type of demand-based

pricing, is a pricing strategy used by airlines, hotels, and cruise

lines. Firms charge different prices to different customers in order

to manage capacity while maximizing revenue. This strategy

works because different customers have different sensitivities to

price. The goal of yield management pricing is to accurately

predict the proportion of customers who fall into each category

and allocate the percentage of the airline or hotel’s capacity

accordingly so that no product goes unsold.

Figure 10.12

Snapshot: Target

Costing Using a

Jeans Example

p. 310 3.2.2 Pricing Strategies Based on the Competition

Sometimes a firm’s pricing strategy involves pricing its wares

near, at, above, or below the competition. A price leadership

strategy, which usually is the rule in an industry dominated by

few firms and called an oligopoly, may be in the best interest of

all firms because it minimizes price competition. Price leadership

strategies are popular because they provide an acceptable and

legal way for firms to agree on prices without ever talking with

each other.

p. 311

3.2.3 Pricing Strategies Based on Customers’ Needs

When firms develop pricing strategies that cater to customers,

they are less concerned with short-term results than with keeping

customers for the long term.

Firms that practice value pricing or everyday low pricing

(EDLP), develop a pricing strategy that promises ultimate value

to consumers. What this means is that, in the customer’s eyes, the

price is justified by what they receive.

Exhibit: Priceline

Chapter 10: Price: What is the Value Proposition Worth?

When firms base price strategies solely or mainly on cost, they

are operating under the old production orientation and not a

customer orientation. Value-based pricing begins with customer,

then considers the competition, and then determines the best

pricing strategy.

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p. 312

3.2.4 New Product Pricing

When a product is new to the market or when there is no

established industry price norm, marketers may use a skimming

price strategy, a penetration pricing strategy, or trial pricing when

they first introduce the item to the market.

Setting a skimming price means that the firm charges a high,

premium price for its new product with the intention of reducing

it in future response to market pressure.

If a product is highly desirable and it offers unique benefits,

demand is price inelastic during the introductory stage of the

product life cycle, allowing a company to recover

research-and-development and promotion costs. When rival

products enter the market, the price is lowered in order for the

firm to remain competitive. Firms focusing on profit objectives in

developing their pricing strategies often set skimming prices for

new products.

A skimming price is more likely to succeed if the product

provides some important benefits to the target market that make

customers feel they must have it no matter what the cost.

For a skimming price to be successful there should also be little

chance that competition can get into the market quickly. In

addition, the market should consist of several customer segments

with different levels of price sensitivity.

Penetration pricing is the opposite of skimming pricing. In this

situation, the company prices a new product very low to sell more

in a short time and gain market share early on. One reason

marketers use penetration pricing is to discourage competitors

from entering the market. The firm first out with a new product

has an important advantage. Experience shows that a pioneering

brand often is able to maintain dominant market share for long

periods. Penetration pricing may act as a barrier-to-entry for

competitors if the prices the market will bear are so low that the

company will not be able to recover development and

manufacturing costs.

Chapter 10: Price: What is the Value Proposition Worth?

p. 312

Trial pricing means that a new product carries a low price for a

limited time to generate a high level of customer interest. Unlike

penetration pricing, in which the company maintains the low

price, in this case it increases the trial price after the introductory

period. The idea is to win customer acceptance first and make

profits later.

3.2.5 Price Segmentation

Price segmentation is the practice of charging different prices to

different market segments for the same product. Peak load

pricing is a pricing plan that sets prices higher during periods

with higher demand. Surge pricing is a pricing plan that raises

prices of a product as demand goes up and lowers it as demand

slides.

Bottom of the pyramid pricing is innovative pricing that will

appeal to consumers with the lowest incomes by brands that wish

to get a foothold in bottom of the pyramid countries.

p. 312 3.3 Step 6: Develop Pricing Tactics

Once marketers have developed pricing strategies, the last step in

price planning is to implement them. The methods companies use

to set their strategies in motion are their pricing tactics.

p. 313 3.3.1 Pricing for Individual Products

The way marketers present a product’s price to a market can make

a big difference. The following are examples:

Two-part pricing requires two separate types of payments to

purchase the product. Payment pricing makes the consumer think

the price is “do-able” by breaking up the total price into smaller

amounts payable over time. Decoy pricing is a pricing strategy

whereby a seller offers at least three similar products; two have

comparable but more expensive prices and one of these two is less

attractive to buyers, thus causing more buyers to buy the higher

priced more attractive item.

Exhibit: Dank

Furniture

►Marketing Moment In-Class Activity

Ask students to think of examples of products (besides cars) that use payment pricing. Who is the

target market (people who may not be able to afford the product)? Are there any ethical concerns

to this tactic? How would you advertise the price?

p. 313 3.3.2 Pricing for Multiple Products

A firm may sell several products that consumers typically buy at

one time. Price bundling means selling two or more goods or

services as a single package for one price—a price that is often

less than the total price of the items if bought individually.

Captive pricing is a pricing tactic a firm uses when it has two

products that work only when used together. The firm sells one

item at a very low price and then makes its profit on the second

Chapter 10: Price: What is the Value Proposition Worth?

high-margin item.

Marketing Moment In-Class Activity

Ask students to identify how fast food restaurants use product bundling? (Example: Happy Meal)

Are there any ethical concerns (i.e., people eating more because they ‘get a deal’)?

p. 314

3.3.3 Distribution-Based Pricing

Distribution-based pricing is a tactic that establishes how firms

handle the cost of shipping products to customers near as well as

far.

F.O.B. pricing is a tactic used in business-to-business marketing.

Often

a company states a price as F.O.B. factory or F.O.B. delivered.

F.O.B. stands for “free on board,” which means the supplier pays

to have the product loaded onto a truck or some other carrier. Also

—and this is important—title passes to the buyer at the F.O.B.

location. F.O.B. factory or F.O.B. origin pricing means that the cost

of transporting the product from the factory to the customer’s

location is the responsibility of the customer. F.O.B. delivered

pricing means that the seller pays both the cost of loading and the

cost of transporting to the customer, amounts it includes in the

selling price.

International Delivery Pricing Terms of Sale

CIF (cost, insurance, freight) is used for ocean

shipments. It means the seller quotes a price for the

goods (including insurance), all transportation, and

miscellaneous charges to the point of debarkation from

the vessel.

CFR (cost and freight) means the quoted price covers

the goods and the cost of transportation to the named

point of debarkation but the buyer must pay the cost of

insurance. This term is typically used only for ocean

shipments.

CIP (carriage and insurance paid to) and CPT

(carriage paid to) include the same provisions as CIF

and CFR. However, they are used for shipment by

modes other than water.

When a firm uses uniform delivered pricing, it adds an average

shipping cost to the price, no matter what the distance from the

manufacturer’s plant—within reason.

Freight absorption pricing means the seller takes on part or all of

the cost of shipping. This policy works well for high-ticket items,

for which the cost of shipping is a negligible part of the sales

price and the profit margin.

Exhibit: The Art

of Shaving

Chapter 10: Price: What is the Value Proposition Worth?

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p. 315

3.3.4 Discounting for Channel Members

A list price, also referred to as a suggested retail price, is the

price that the manufacturer sets as the appropriate price for the

end consumer to pay. In pricing for members of the channel,

marketers recognize that retailers and wholesalers have costs to

cover and profit targets to reach as well. They often begin with

the list price and then use a number of discounting tactics to

implement pricing to members of the channel of distribution.

Such tactics include the following:

Trade or functional discounts: Because the channel

members perform selling, credit, storage, and

transportation services that the manufacturer would

otherwise have to provide, manufacturers normally

offer trade or functional discounts to channel

intermediaries. These discounts are usually set

percentage discounts off the suggested retail or list

price for each channel level.

Quantity discounts: To encourage larger purchases from

distribution channel partners or from large

organizational customers, marketers may offer quantity

discounts, or reduced prices for purchases of larger

quantities. Cumulative quantity discounts are based on

a total quantity bought within a specified time, often a

year/. They encourage a buyer to stick with a single

seller instead of moving from one supplier to another.

Cumulative quantity discounts often take the form of

rebates, in which case the firm sends the buyer a

rebate check at the end of the discount period or,

alternatively, gives the buyer credit against future

orders. Non-cumulative quantity discounts are based

only on the quantity purchased with each individual

order and encourage larger single orders but do little to

tie the buyer and the seller together.

Cash discounts: Many firms try to entice their

customers to pay their bills quickly by offering cash

discounts.

Seasonal discounts: Seasonal discounts are price reductions

offered only during certain times of the year.

p. 315 4. PRICING AND ELECTRONIC COMMERCE

Because sellers are connected to buyers around the globe as never

before through the Internet, corporate networks, wireless setups,

and marketers can offer deals tailored to a single person at a

single moment. Many experts suggest that technology is creating

a consumer revolution that might change pricing forever—and

perhaps create the most efficient market ever. The Internet also

enables firms that sell to other businesses (B2B firms) to change

Chapter 10: Price: What is the Value Proposition Worth?

p. 316

p. 317

their prices rapidly as they adapt to changing costs.

4.1 Dynamic Pricing Strategies

One of the most important opportunities the Internet offers is

dynamic pricing, in which the seller can easily adjust the price to

meet changes in the marketplace.

4.2 Internet Price Discrimination

Internet price discrimination is an Internet pricing strategy that

charges different prices to different customers for the same

product. Is price discrimination illegal? As long as the company

doesn’t charge different prices based on a demographic

characteristic such as gender or race, it is not. Whether it is

ethical, however, is debatable.

4.3 Online Auctions

Online auctions allow shoppers to bid on everything from

bobbleheads to health-and-fitness equipment to a Sammy Sosa

home-run ball. Auctions provide a second Internet pricing

strategy. Perhaps the most popular auctions are the C2C auctions

such as those on eBay. The eBay auction is an open auction,

meaning that all the buyers know the highest price bid at any

point in time. On many Internet auction sites, the seller can set a

reserve price, a price below which the item will not be sold.

A reverse auction is a tool used by firms to manage their costs in

business-to-business buying. While in a typical auction, buyers

compete to purchase a product, in reverse auctions; sellers

compete for the right to provide a product at, hopefully, a low

price.

4.4 Freemium Pricing Strategies

A freemium strategy is a business strategy in which a product in

its most basic version is provided free of charge but the company

charges money (the premium) for upgraded versions of the

product with more features, greater functionality, or greater. The

freemium pricing strategy has been most popular in digital

offerings such as software media, games, or web services where

the cost of one additional copy of the product is negligible.

4.5 Pricing Advantages for Online Shoppers

The Internet creates unique pricing challenges for marketers

because consumers and business customers are gaining more

control over the buying process. Consumers have become more

price sensitive.

►Marketing Moment In-Class Activity

Ask if a student or someone the student knows participated in an e-bay auction. How is it

emotionally different from just going to the store and paying the price on the price tag (emotional

Chapter 10: Price: What is the Value Proposition Worth?

excitement)? How does this kind of consumer behavior exemplify the “experience economy?”

p. 317

p. 318

5. PSYCHOLOGICAL, LEGAL AND ETHICAL ASPECTS

OF PRICING

5.1 Psychological Issues in Setting Prices

Much of what we’ve said about pricing depends on economists’

notion of a customer who evaluates price in a logical, rational

manner.

5.1.1 Buyers’ Pricing Expectation

Often consumers base their perceptions of price on what they

perceive to be the customary or fair price. When the price of a

product is above or sometimes even when it is below what

consumers expect they are less willing to purchase the product.

Figure 10.13

Snapshot:

Psychological,

Legal, and

Ethical Aspects

of Pricing

►Marketing Moment In-Class Activity

Ask students to write down their “internal reference price” for products they are likely to

purchase (i.e., CD, can of pop, fast food dinner, computer, jeans, shoes). Compare prices between

students. Why are some internal reference prices consistent while others are different?

p. 318 5.1.2 Internal Reference Prices

Sometimes consumers’ perceptions of the customary price of a

product depend on their internal reference price. That is, based on

experience, consumers have a set price or a price range in mind

that they refer to in evaluating a product’s cost.

In some cases, marketers try to influence consumers’ expectations

of what a product should cost when they use reference-pricing

strategies. For example, manufacturers may compare their price to

competitors’ prices when they advertise. Similarly, a retailer may

display a product next to a higher-priced version of the same or a

different brand.

Two results are likely: On the one hand, if the prices (and other

characteristics) of the two products are close, the consumer will

probably feel the product quality is similar. This is an

assimilation effect. On the other hand, if the prices of the two

products are too far apart, a contrast effect may result, in which

the customer equates the gap with a big difference in quality.

p. 319 5.1.3 Price–Quality Inferences

Consumers make price-quality inferences about a product when

they use price as a cue or an indicator of quality. If consumers are

unable to judge the quality of a product through examination or

prior experience, they usually will assume that the higher-price

product is the higher-quality product.

Brain scans show that—contrary to conventional wisdom—

Chapter 10: Price: What is the Value Proposition Worth?

consumers who buy something at a discount experience less

satisfaction than people who pay full price for the very same

thing. Researchers call this the price-placebo effect.

p. 319

p. 320

5.2 Psychological Pricing Strategies

Setting a price is part science, part art. Marketers must understand

psychological aspects of pricing when they decide what to charge

for their products or services.

5.2.1 Odd–Even Pricing

Marketers have assumed that there is a psychological response to

odd prices that differ from the responses to even prices. Habit

may also play a role. Research on the difference in perceptions of

odd versus even prices indeed supports the argument that prices

ending in 99 rather than 00 lead to increased sales.

Some prices are set at even numbers because of necessity. Lottery

tickets and admission to sporting events are two examples. Many

luxury items such as jewelry, golf course fees, and resort

accommodations use even dollar prices to set them apart. When

prices are given with dollar signs or even the word dollar,

customers spend less.

5.2.2 Price Lining

Marketers often apply their understanding of the psychological

aspects of pricing in a practice they call price lining, whereby

items in a product line sell at different prices, or price points. If

you want to buy a new digital camera, you will find that most

manufacturers have one “stripped-down” model for $100 or less.

A better-quality but still moderately priced model likely will be

around $200, while a professional quality camera with multiple

lenses might set you back $1,000 or more. Price lining provides

the different ranges necessary to satisfy each segment of the

market.

For marketers this technique is a way to maximize profits. A firm

charges each customer the highest price the he is willing to pay.

5.2.3 Prestige Pricing

Sometimes luxury goods marketers use a prestige pricing strategy

that turns the typical assumption about price-demand

relationships on its head: Contrary to the “rational” assumption

that we value a product or service more as the price goes down, in

these cases, believe it or not, people tend to buy more as the price

Chapter 10: Price: What is the Value Proposition Worth?

goes up!

Use website here: www.landsend.com Lands’ End website

p. 320

p. 321

5.3 Legal and Ethical Considerations in B2C Pricing

The free enterprise system is founded on the idea that the

marketplace will regulate itself. Unfortunately, the business world

includes the greedy and unscrupulous. Government has found it

necessary to enact legislation to protect consumers and to protect

businesses from predatory rivals.

5.3.1 Deceptive Pricing Practices

Unscrupulous businesses may advertise or promote prices in a

deceptive way. The Federal Trade Commission (FTC), state

lawmakers, and private bodies such as the Better Business Bureau

have developed pricing rules and guidelines to meet the

challenge.

Another deceptive pricing practice is the bait-and-switch tactic,

whereby a retailer will advertise an item at a very low price—the

bait—to lure customers into the store. However, it is almost

impossible to buy the advertised item—salespeople like to say

(privately) that the item is “nailed to the floor.” The salespeople

do everything possible to get the unsuspecting customers to buy a

different, more expensive, item—the switch.

It is complicated to enforce laws against bait-and-switch tactics

because these practices are similar to the legal sales technique of

“trading up.” Simply encouraging consumers to purchase a

higher-priced item is acceptable, but it is illegal to advertise a

lower-priced item when it’s not a legitimate, bona fide offer that is

available if the customer demands it. The FTC may determine if

an ad is a bait-and-switch scheme or a legitimate offer by

checking to see if a firm refuses to show, demonstrate, or sell the

advertised product; disparages it; or penalizes salespeople who do

sell it.

p. 321 5.3.2 Loss-Leader Pricing and Unfair Sales Acts

Some retailers advertise items at very low prices or even below

cost and are glad to sell them at that price because they know that

once in the store, customers may buy other items at regular prices.

Marketers call this loss leader pricing; they do it to build store

traffic and sales volume.

Some states frown on loss leader practices so they have passed

legislation called unfair sales acts (also called unfair trade

practices acts). These laws or regulations prohibit wholesalers

and retailers from selling products below cost. These laws aim to

protect small wholesalers and retailers from larger competitors

Chapter 10: Price: What is the Value Proposition Worth?

p. 321

p. 322

p. 323

because the “big fish” have the financial resources that allow

them to offer loss leaders or products at very low prices—they

know that the smaller firms can’t match these bargain prices.

5.3.3 Misleading Merchandising

Sometimes, the merchandising activities in the retail store are

deceptive or at least suspicious. Consumers assume that items in

an end-aisle display are being sold at a discounted price. When

retailers display regularly priced merchandise in these displays,

they may be accused of taking advantage of consumers.

5.4 Legal Issues in B2B Pricing

Some of the more significant illegal B2B pricing activities include

price discrimination, price fixing, and predatory pricing.

5.4.1 Illegal Business-to-Business Price Discrimination

The Robinson-Patman Act includes regulations against price

discrimination in interstate commerce. Price discrimination

regulations prevent firms from selling the same product to

different retailers and wholesalers at different prices if such

practices lessen competition.

5.4.2 Price-Fixing

Price fixing occurs when two or more companies conspire to

keep prices at a certain level. Horizontal price-fixing occurs when

competitors making the same product jointly determine what

price they each will charge. Sometimes manufacturers or

wholesalers attempt to force retailers to charge a certain price for

their product. When vertical price-fixing occurs, the retailer that

wants to carry the product has to charge the “suggested” retail

price.

5.4.3 Predatory Pricing

Predatory pricing means that a company sets a very low price for

the purpose of driving competitors out of business. Later, when

they have a monopoly, they turn around and increase prices.

►ETHICS CHECK

Find out what other students taking this course would do and why

at www.mymktlab.com

If you were advising Uber’s executives, would you encourage

them to end the service’s surge pricing strategy to prevent the

company from losing customers who are angry about such price

hikes?

Ripped from the

Headlines:

Ethical/

Sustainable

Decisions in the

Real World

Real People, Real Choices: Here’s My Choice at Converse

Chapter 10: Price: What is the Value Proposition Worth?

Betsy chose option #1.