CHAPTER 12
Pricing Concepts and Management
TEACHING RESOURCES QUICK REFERENCE GUIDE
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Purpose and Perspective
IRM, p. 1
Lecture Outline
IRM, p. 2
Discussion Starters
IRM, p. 12
Class Exercises
IRM, p. 13
Chapter Quiz
IRM, p. 16
Semester Project
IRM, p. 17
Answers to Issues for Discussion and Review
IRM, p. 18
Answers to Developing Your Marketing Plan
IRM, p. 22
Comments on Video Case 12
IRM, p. 23
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Purpose and Perspective
This chapter introduces basic pricing concepts and issues. First, it discusses price and nonprice
competition. Next, it discusses the stages for establishing prices. The chapter identifies the pricing
objectives like survival, profit, market share, etc. Next, the chapter talks about how marketers assess the
target market’s evaluation of price. It follows this with an explanation of demand curves, demand
fluctuations, and assessment of price elasticity of demand. Next, it explores marginal analysis and break-
even analysis. It also identifies and examines various factors that affect marketers’ pricing decisions. It
discusses how competitors’ prices are evaluated as well as selecting a basis for pricing: cost, demand,
and/or competition. This chapter explores the various types of pricing strategies. It examines the
determination of a specific price. Finally, it considers several issues associated with the pricing of
products for business markets, focusing on price discounting, geographic pricing, and transfer pricing.
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LECTURE OUTLINE
Price competition occurs when a seller emphasizes a product’s low price and sets a price that equals or
beats that of competitors. Non-price competition is competition based on factors other than price. It is
used most effectively when a seller can distinguish its product through distinctive product quality,
customer service, promotion, packaging, or other features.
Marketers can use the eight stages of a process when setting prices. Figure 12.1 illustrates these stages.
• Stage 1 is developing a pricing objective that is compatible with the organization’s overall
marketing objectives.
• Stage 2 entails assessing the target market’s evaluation of price.
• In Stage 3, marketers should examine a product’s demand and the price elasticity of demand.
• Stage 4 consists of analyzing demand, cost, and profit relationships—it is a necessary step in
estimating the economic feasibility of various price alternatives.
• Stage 5 involves evaluating competitors’ prices, which helps determine the role of price in the
marketing strategy.
• Stage 6 requires choosing a basis for setting prices.
• Stage 7 is selecting a pricing strategy, or determining the role of price in the marketing mix.
• Stage 8 involves determining the final price. This final step depends on environmental forces and
marketers’ understanding and use of a systematic approach to establishing prices.
I. Development of Pricing Objectives
A. The first step in setting prices is developing pricing objectives—goals that describe what a firm
wants to achieve through pricing.
1. Developing pricing objectives is an important task because they form the basis for decisions
for other stages of the pricing process.
2. Pricing objectives must be consistent with organizational and marketing objectives because
pricing objectives influence decisions in many functional areas, including finance,
accounting, and production.
3. A marketer can use both short– and long-term pricing objectives and can employ one or more
multiple pricing objectives.
B. Survival
1. One of the most fundamental pricing objectives is survival. This generally means
temporarily setting prices low, even at times below costs, in order to attract more
sales.
a. Because price is a flexible variable, it is sometimes used to keep a company afloat by
increasing sales volume.
b. Most organizations will tolerate short-run losses, internal upheaval, and other
difficulties if these conditions are necessary for survival.
C. Profit
1. The objective of profit maximization is rarely operational because it is difficult to measure
its achievement.
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a. Therefore, profit objectives tend to be set at levels that the owners and top-
level decision makers view as satisfactory and attainable.
2. Specific profit objectives may be stated in terms of either actual dollar amounts or in terms
of a percentage of sales revenues.
D. Return on Investment
1. Pricing to attain a specified rate of return on the company’s investment is a profit-related
pricing objective.
2. Most pricing objectives based on return on investment (ROI) are achieved by trial and
error because not all cost and revenue data needed to project the return on investment are
available when setting prices.
E. Market Share
1. Many firms establish pricing objectives to maintain or increase market share, which is a
product’s sales in relation to total industry sales, in part because they recognize that high
relative market share often translates into higher profits.
a. The Profit Impact of Market Strategies (PIMS) studies have shown that both market
share and product quality influence profitability.
2. Maintaining or increasing market share need not depend on growth in industry sales.
a. An organization’s market share can increase even when sales for the total industry are
flat or decreasing.
b. An organization’s sales volume can increase while its market share decreases if the
overall market is growing.
F. Cash Flow
1. Some organizations set prices to recover cash as quickly as possible.
2. Financial managers are interested in quickly recovering capital that has been spent to
develop products.
3. A possible disadvantage of this pricing objective is high prices, which might enable
competitors with lower prices to gain a large share of the market.
G. Status Quo
1. In some cases, an organization may be in a favorable position and may set an objective of
status quo.
2. Status quo objectives can focus on several dimensions, including maintaining a certain
market share, meeting (but not beating) competitors’ prices, achieving price stability, or
maintaining a favorable public image.
3. A status quo pricing objective can reduce a firm’s risks by helping stabilize demand for its
products.
4. The use of status quo pricing objectives sometimes minimizes price as a competitive tool,
which can lead to a climate of non-price competition within an industry.
H. Product Quality
1. A high price on a product may have the effect of signaling to customers that the product is of
a high quality.
2. An objective of product quality leadership in the market normally results in charging a high
price to cover the high product quality and, perhaps, the high cost of materials, research, and
development.
3. The products and brands that customers perceive to be of high quality are more likely to
survive in a competitive marketplace because they trust these products more, even if the
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prices are higher.
II. Assessment of the Target Market’s Evaluation of Price
A. After developing pricing objectives, marketers next must assess the target market’s evaluation of
price.
1. The importance of price depends on the type of product, the type of target market, and the
purchase situation.
B. Today, because some consumers are seeking less-expensive products and shopping more
selectively, some manufacturers and retailers are focusing on the value of their products in
communications with customers.
1. Value combines a product’s price with quality attributes, which are used by customers to
differentiate between competing brands.
2. Understanding the importance of a product to customers, as well as their expectations of
quality and value, helps a marketer correctly assess the target market’s evaluation of price.
III. Analysis of Demand
A. Marketing research and forecasting techniques yield data such as estimates of sales potential, or the
quantity of a product that could be sold during a specific period.
1. These estimates help marketers to establish the relationship between a product’s
price and the quantity demanded.
B. Demand Curves
1. For most products, there is an inverse relationship between price and demand. The quantity
demanded goes up as the price goes down and goes down as the price goes up.
2. A normal demand curve is a graph of the quantity of products expected to be sold at various
prices, if other factors remain constant.
a. Demand depends on other factors in the marketing mix, including product quality,
promotion, and distribution.
3. There are many types of demand, and not all conform to the classic demand curve. Prestige
products, for example, tend to sell better at high prices than at low ones.
C. Demand Fluctuations
1. Changes in buyers’ needs, variations in the effectiveness of other marketing mix variables,
the presence of substitutes, and dynamic environmental factors can influence demand.
2. In some cases, demand fluctuations are predictable, but they are unpredictable in others,
creating problems for some companies unless they can learn to anticipate fluctuations and
develop new products and prices to respond accordingly.
D. Assessing Price Elasticity of Demand
1. Price elasticity of demand provides a measure of the sensitivity of consumer demand for a
product or a product category to changes in price; it is formally defined as the percentage
change in quantity demanded relative to a given percentage change in price.
2. Setting a price is much easier if marketers can determine the price elasticity of demand.
a. If demand is elastic, a shift in price causes an opposite change in total revenue: an
increase in price will decrease total revenue, and a decrease in price will increase total
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revenue.
b. Inelastic demand results in the same direction as total revenue: an increase in price
will increase total revenue, and a decrease in price will decrease total revenue.
3. Marketers cannot base prices solely on elasticity considerations; they must also consider the
costs associated with different sales volumes and evaluate what happens to profits.
IV. Demand, Cost, and Profit Relationships
A. The analysis of demand, cost, and profit is important because customers are becoming less tolerant
of price increases, which forces manufacturers to find new ways to maintain high quality and low
costs.
B. Marginal Analysis
1. Marginal analysis examines what happens to a firm’s costs and revenues when production
(or sales volume) is changed by one unit.
2. To determine the costs of production, it is necessary to distinguish among several types of
costs.
a. Fixed costs do not vary with changes in the number of units produced or sold.
(1) Average fixed cost is the fixed cost per unit produced, and is calculated by
dividing fixed costs by the number of units produced.
b. Variable costs directly relate to changes in the number of units produced or sold.
They are usually constant per unit.
(1) Average variable cost is the variable cost per unit produced, calculated by
dividing the variable costs by the number of units produced.
c. Total cost is the sum of the average fixed costs and the average variable costs,
multiplied by the quantity produced.
(1) The average total cost is the sum of the average fixed cost and the average
variable cost.
d. Marginal cost (MC) is the extra cost a firm incurs when it produces one additional
unit of a product.
e. Average fixed cost declines as output increases. Average total cost decreases as long
as MC is less than the average total cost, and it increases when MC rises above
average total cost.
3. Marginal revenue (MR) is the change in total revenue that occurs when a firm sells an
additional unit of a product.
a. Most firms face downward-sloping demand curves for their products; in other words,
they must lower their prices to sell additional units.
(1) This situation means that each additional unit of product sold provides the
organization with less revenue than the previous unit sold.
(2) Eventually MR reaches zero, and the sale of additional units actually reduces
the organization’s profits.
b. The point of maximum profit is the point at which marginal costs are equal to
marginal revenues.
4. This discussion of marginal analysis may give the false impression that pricing can be highly
precise.
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a. If revenue (demand) and cost (supply) remained constant, prices could be set for
maximum profits. In practice, however, cost and revenue frequently change.
5. Marginal analysis is to be used only as a model; the marketer can benefit by understanding
the relationship between MC and MR in setting prices of existing products.
C. Break-even Analysis
1. The break-even point is the point at which the costs of producing the product equal the
revenue from selling the product. It is calculated by dividing the fixed costs by price minus
variable costs.
2. To use break-even analysis effectively, a marketer should determine the break-even point for
several alternative prices in order to compare the relative effects on total revenue, total
costs, and the break-even point. This comparative analysis will identify the highly
undesirable price alternatives that should be avoided.
3. Breakeven analysis is simple and straightforward, but it assumes that the quantity demanded
is basically fixed (inelastic) and that the major task in setting prices is to recover costs. It
does not focus on how to achieve a pricing objective.
V. Evaluation of Competitors’ Prices
A. Marketers are generally in a better position to establish prices when they know the competition’s
prices; discovering competitors’ prices may be a regular function of marketing research.
B. Competitors’ prices are often closely guarded secrets and may be difficult to uncover.
C. Marketers in an industry in which price competition prevails need competitive price information to
ensure their organization’s prices are the same, or slightly lower than, their competitors’ prices.
Sometimes a firm may choose to price slightly above the competition (e.g. Apple).
VI. Selection of a Basis for Pricing
A. The sixth stage in the price setting process involves selecting a basis for pricing: cost, demand,
and/or competition.
B. The appropriate pricing basis is affected by the type of product, the market structure of the
industry, the brand’s market share position relative to competing brands, and customer
characteristics.
C. Cost-Based Pricing
1. When using cost-based pricing, an organization determines price by adding a flat dollar
amount or a percentage to the cost of the product. It does not always take into account the
economic aspects of supply and demand.
2. Cost-based pricing is straightforward and easy to implement. Two common forms of cost–
based pricing are cost-plus and markup pricing.
a. Cost-plus pricing is a method whereby the seller’s costs are determined (usually
during a project or after a project is completed), and then a specified dollar amount or
percentage of the cost is added to the seller’s cost to establish the price.
(1) This is appropriate when production costs are difficult to predict.
(2) One pitfall for the buyer is that the seller may increase stated costs to establish a
larger profit base. Additionally, some costs, such as overhead, may be difficult
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to determine.
(3) Cost-plus pricing tends to be popular during periods of rapid inflation,
especially when the producer uses raw materials that frequently fluctuate in
price.
b. Through markup pricing, which is common among retailers, a product’s price is
derived by adding a predetermined percentage of the cost, called markup, to the cost
of the product.
(1) Markups can range a great deal, depending on the product and the situation.
(2) Using a rigid percentage markup for a specific product category reduces pricing
to a routine task that can be performed quickly.
D. Demand-Based Pricing
1. With demand-based pricing, customers pay a higher price at times when demand for the
product is strong and a lower price when demand is weak.
2. To use demand-based pricing, a marketer must be able to estimate the amounts of a product
consumers will demand at different times and how demand will be affected by changes
in the price; effectiveness depends on the marketer’s ability to estimate demand accurately.
3. Compared with cost-based pricing, demand-based pricing places a firm in a better position to
reach high profit levels, assuming demand is strong at times and buyers value the product
at levels sufficiently above the product’s cost.
E. Competition-Based Pricing
1. Competition-based pricing is pricing primarily influenced by competitors’ prices.
a. This is a common method when competing products are relatively homogeneous and
the organization is serving markets in which price is a key purchase consideration.
2. A firm that uses competition-based pricing may choose to price below competitors’ prices or
at the same level.
VII. Selection of a Pricing Strategy
A. A pricing strategy is an approach or a course of action designed to achieve pricing and marketing
objectives. Pricing strategies help marketers solve the practical problems of setting prices.
B. New-Product Pricing
1. The two primary types of new-product pricing strategies are price skimming and penetration
pricing. An organization can use one or both over a period of time.
a. Price Skimming
(1) Some consumers are willing to pay a high price for an innovative product, either
because of its novelty or because of the prestige or status that ownership
confers.
(2) Price skimming is the strategy of charging the highest possible price for a
product during the introduction stage of its life-cycle.
(3) One danger, however, is that this pricing strategy might make the product
appear more lucrative than it actually is to potential competitors.
b. Penetration Pricing
(1) At the opposite extreme, penetration pricing is the strategy of setting a low
price for a new product.
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(2) The main purpose of setting a low price is to build market share quickly in order
to encourage product trial by the target market and discourage competitors from
entering the market.
(3) A disadvantage of this pricing strategy is that it places the firm in a less-flexible
pricing position. It is more difficult to raise prices significantly than it is to
lower them.
C. Differential Pricing
1. An important issue in pricing is whether to use a single price or different prices for the same
product.
a. Using a single price has several benefits, including that it is simple, easily understood
by employees and customers, and it reduces the chance of an adversarial relationship
developing between marketer and customer.
2. Differential pricing means charging different prices to different buyers for the same quality
and quantity of product.
a. The market must consist of multiple segments with different price sensitivities, and the
pricing method should be used in a way that avoids confusing or antagonizing
customers.
b. Negotiated Pricing
(1) Negotiated pricing occurs when the final price is established through
bargaining between the seller and the customer.
(2) Even when there is a predetermined stated price or a price list, negotiated
pricing may still be used to establish the final sales price.
c. Secondary-Market Pricing
(1) Secondary-market pricing means setting one price for the primary target
market and a different price for another market.
(2) Often the price charged in the secondary market is lower.
(3) However, when the costs of serving a secondary market are higher than normal,
secondary-market customers may have to pay a higher price.
d. Periodic Discounting
(1) Periodic discounting is the temporary reduction of prices on a patterned or
systematic basis.
(a) For example, many retailers have annual holiday sales, and some apparel
stores have regular seasonal sales.
(2) A major problem with periodic discounting is, if the discounts follow a pattern,
customers may wait to make purchases until they can get the sale price.
e. Random Discounting
(1) Random discounting is temporarily reducing prices on an unsystematic basis.
(a) This is done to attract new customers and reduce predictability of price
reductions by current customers.
f. Psychological Pricing
(1) Psychological pricing strategies encourage purchases based on consumers’
emotional responses, rather than on economically rational ones.
(a) These strategies are used primarily for consumer products, rather than
business products, because most business purchases follow a systematic
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and rational approach.
g. Odd-Number Pricing
(1) Odd-number pricing is the strategy of setting prices using odd numbers that
are slightly below whole-dollar amounts.
(2) Sellers who use this strategy believe that odd-number prices increase sales
because consumers register the dollar amount, not the cents. The strategy is not
limited to low-priced items.
h. Multiple-Unit Pricing
(1) Many retailers (and especially supermarkets) practice multiple-unit pricing,
setting a single price for two or more units of a product.
(2) Especially for frequently-purchased products, this strategy can increase sales
through encouraging consumers to purchase multiple units when they might
otherwise have only purchased one at a time.
i. Reference Pricing
(1) Reference pricing means pricing a product at a moderate level and positioning
it next to a more expensive model or brand in the hope that the customer will
use the higher price as a reference point (i.e., a comparison price).
j. Bundle Pricing
(1) Bundle pricing is the packaging together of two or more products, usually of a
complementary nature, to be sold for a single price.
(2) To be attractive to customers, the single price usually is considerably less than
the sum of the prices of the individual products.
k. Everyday Low Prices (EDLPs)
(1) To reduce or eliminate the use of frequent short-term price reductions, some
organizations use an approach referred to as everyday low prices (EDLPs).
(a) A major problem with this approach is that customers can have mixed
responses to it.
l. Customary Pricing
(1) In customary pricing, certain goods are priced on the basis of tradition.
m. Product-Line Pricing
(1) Product-line pricing means establishing and adjusting the prices of multiple
products within a product line.
(2) Product-line pricing can provide marketers with flexibility in setting prices.
(3) When marketers employ product-line pricing, they have several strategies from
which to choose.
(a) These include captive pricing, premium pricing, and price lining.
n. Captive Pricing
(1) When marketers use captive pricing, the basic product in a product line is
priced low, but the price on the items required to operate or enhance it are
higher.
o. Premium Pricing
(1) Premium pricing occurs when the highest-quality product or the most-versatile
and most desirable version of a product in a product line is assigned the highest
price.
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p. Price Lining
(1) Price lining is the strategy of selling goods only at certain predetermined prices
that reflect explicit price breaks.
(a) It eliminates minor price differences from the buying decision—both for
customers and for managers who buy merchandise to sell in these stores.
q. Promotional Pricing
(1) Price, as an ingredient in the marketing mix, often is coordinated with
promotion.
(a) The two variables sometimes are so interrelated that the pricing policy is
promotion-oriented.
r. Price Leaders
(1) Sometimes a firm prices a few products below the usual markup, near cost, or
even below cost, which results in what is known as price leaders.
(2) This type of pricing is used most often in supermarkets and restaurants to attract
customers by offering especially low prices on a few items, with the expectation
that they will purchase other items as well.
s. Special-event pricing
(1) Special-event pricing involves advertised sales or price cutting linked to a
holiday, season, or event.
(2) If the pricing objective is survival, then special sales events may be designed to
generate necessary operating capital.
t. Comparison Discounting
(1) Comparison discounting sets the price of a product at a specific level and
simultaneously compares it with a higher price.
(a) The higher price may be the product’s previous price, the price of a
competing brand, the product’s price at another retail outlet, or a
manufacturer’s suggested retail price.
(b) However, because this pricing strategy has led to deceptive pricing
practices, the Federal Trade Commission has established guidelines for
comparison discounting. For instance, if the higher price against which
the comparison is made is the price formerly charged for the product,
sellers must have made the previous price available to customers for a
reasonable period of time.
VIII. Determination of a Specific Price
A. A pricing strategy will yield a certain price or range of prices, which is the final stage in the price
setting process.
1. However, this price may need refinement to make it consistent with circumstances, such as a
sluggish economy, and with pricing practices in a particular market or industry.
B. Pricing strategies should help in setting a final price.
C. Marketers must establish pricing objectives; have considerable knowledge about target market
customers; and determine demand, price elasticity, costs, and competitive factors.
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IX. Pricing for Business Markets
A. Setting prices for business products can be quite different from setting prices for consumer
products, owing to several factors such as size of purchases, transportation considerations, and
geographic issues.
B. The three types of pricing associated with business products are geographic pricing, transfer
pricing, and discounting.
C. Geographic Pricing
1. Geographic pricing strategies deal with delivery costs.
2. F.O.B. origin pricing stands for “free on board at the point of origin,” which means that the
price does not include freight charges.
a. It requires the buyer to pay the delivery costs, which include transportation from the
seller’s warehouse to the buyer’s place of business.
3. F.O.B. destination indicates that the product price does include freight charges, and therefore
the seller is responsible for these charges.
D. Transfer Pricing
1. When one unit in an organization sells a product to another unit, transfer pricing occurs.
2. A transfer price is determined by calculating the cost of the product, which can vary
depending on the types of costs included in the calculations.
3. The choice of the costs to include when calculating the transfer price depends on the
company’s management strategy and the nature of the units’ interaction.
E. Discounting
1. A discount is a deduction off the price of an item.
2. Producers and sellers offer a wide variety of discounts to their customers, including trade,
quantity, cash, and seasonal discounts as well as allowances.
a. Trade discounts are taken off the list prices and are offered to marketing
intermediaries, or middlemen.
b. Quantity discounts are given to customers who buy in large quantities.
c. Cash discounts are incentives offered for prompt payment.
d. A seasonal discount is a price reduction to buyers who purchase out of season.
e. An allowance is a reduction in price to achieve a desired goal.
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DISCUSSION STARTERS
Discussion Starter 1: Irrational Demand
ASK: For an established product category, how are consumers’ minds changed about what the price
should be for the product?
Often newcomers to a category seek to shift our pricing expectations upward. This was what Starbucks
Discussion Starter 2: Using Reference Pricing
ASK: How do you know you are getting a good price?
When shopping for an infrequently purchased product, consumers often rely on reference pricing. Many
ASK: How effective is Overstock’s use of reference pricing to consumers?