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Chapter 19: Pricing Concepts
1
Chapter 19
Pricing Concepts
This chapter begins with the learning outcome summaries followed by a set of lesson plans for
instructors to use to deliver the content.
• Lecture (for large sections) on page 5
• Company Clips (video) on page 7
• Group Work (for smaller sections) on page 9
Review and Assignments begin on page 10
Review questions
Application questions
Application exercise
Ethics Exercise
Video assignment
Case assignment
Great Ideas for Teaching Marketing from faculty around the country begin on page 25
Chapter 19: Pricing Concepts
2
Learning Outcomes
19-1 Discuss the importance of pricing decisions to the economy and to the individual
firm
Price means one thing to the consumer and something else to the seller. To the consumer, it is the
Price × Unit = Revenue
19-2 List and explain a variety of pricing objectives
Establishing realistic and measurable pricing objectives is a critical part of any firm’s marketing
strategy. Pricing objectives are commonly classified into three categories: profit oriented, sales
19-3 Explain the role of demand in price determination
Demand is a key determinant of price. When establishing prices, a firm must first determine
demand for its product. The quantity of a product that people will buy depends on its price.
19-4 Understand the concepts of dynamic pricing and yield management systems
Chapter 19: Pricing Concepts
3
When competitive pressures are high, a company must know when it should raise or lower prices
to maximize its revenues. Dynamic pricing allows companies to adjust prices very quickly, often
19-5 Describe cost-oriented pricing strategies
The other major determinant of price is cost. Marketers use several cost-oriented pricing
19-6 Demonstrate how the product life cycle, competition, distribution and promotion
strategies, customer demands, the Internet and extranets, and perceptions of quality
can affect price
The price of a product normally changes as it moves through the life cycle and as demand for the
product and competitive conditions change. Management often sets a high price at the
19-7 Describe the procedure for setting the right price
The process of setting the right price on a product involves four major steps: (1) establishing
Chapter 19: Pricing Concepts
4
19-8 Identify the legal constraints on pricing decisions
Government regulation helps monitor four major areas of pricing: unfair trade practices, price
fixing, price discrimination, and predatory pricing. Many states have enacted unfair trade
19-9 Explain how discounts, geographic pricing, and other pricing tactics can be used to
fine-tune a base price
Several techniques enable marketing managers to adjust prices within a general range in
response to changes in competition, government regulation, consumer demand, and promotional
and positioning goals. Techniques for fine-tuning a price can be divided into various categories:
violating the terms of a purchase contract. The perceived fairness or unfairness of a penalty may
affect some consumers’ willingness to patronize a business in the future.
Key Terms
Bait pricing
Inelastic demand
Promotional allowance
(trade allowance)
Base price
Keystoning
Quantity discount
Basing-point pricing
Leader pricing (loss-leader
pricing)
Rebate
Chapter 19: Pricing Concepts
5
Break-even analysis
Market share
Return on investment (ROI)
Cash discount
Markup pricing
Revenue
Consumer penalty
Noncumulative quantity discount
Seasonal discount
Cumulative quantity
discount
Odd-even pricing (psychological
pricing)
Single-price tactic
Demand
Penetration pricing
Status quo pricing
Dynamic pricing
Predatory pricing
Supply
Elastic demand
Price
Two-part pricing
Elasticity of demand
Price bundling
Unfair trade practice acts
Extranet
Price fixing
Uniform delivered pricing
Fixed cost
Price lining
Value-based pricing
Flexible pricing (variable
pricing)
Price skimming
Variable cost
Fob origin pricing
Price strategy
Yield management systems
(YMS)
Freight absorption pricing
Profit
Zone pricing
Functional discount (trade
discount)
Lesson Plan for Lecture
Brief Outline and Suggested PowerPoint Slides
Learning Outcomes and Topics
PowerPoint Slides
LO1 Discuss the importance of pricing
decisions to the economy and to the
individual firm
19-1 The Importance of Price
1. Pricing Concepts
2. Learning Outcomes
3. Learning Outcomes (continued)
4. Importance of Price
5. Price
6. Importance of Price to Marketing
Managers
LO2 List and explain a variety of pricing
objectives
19-2 Pricing Objectives
7. Pricing Objectives
8. Pricing Objectives
9. Profit-Oriented Pricing Objectives
10. Sales-Oriented Pricing Objectives
11. Status Quo Pricing Objectives
LO3 Explain the role of demand in price
determination
12. Demand Determinant of Price
13. Nature of Demand
Chapter 19: Pricing Concepts
6
Learning Outcomes and Topics
PowerPoint Slides
19-3 The Demand Determinant of Price
14. Elasticity of Demand
15. Factors that Affect Elasticity of Demand
LO4 Understand the concepts of dynamic
pricing and yield management systems
19-4 The Power of Dynamic Pricing and
Yield Management Systems
16. Power of Dynamic Pricing and Yield
Management Systems
17. Dynamic Pricing and Yield
Management System (YMS)
LO5 Describe cost-oriented pricing strategies
19-5 The Cost Determinant of Price
18. Cost Determinant of Price
19. Types of Cost
20. Markup Pricing
21. Markup Pricing (continued)
22. Break-Even Analysis
LO6 Demonstrate how the product life cycle,
competition, distribution and promotion
strategies, customer demands, the Internet
and extranets, and perceptions of quality
can affect price
19-6 Other Determinants of Price
23. Other Determinants of Price
24. Other Determinants of Price
25. Stages in the Product Life Cycle
26. Distribution Strategies
27. Impact of the Internet and Extranets
28. Relationship of Price to Quality
LO7 Describe the procedure for setting the
right price
19-7 How to Set a Price on a Product
29. How to Set a Price on a Product
30. Steps in Setting the Right Price on a
Product
31. Price Strategy - Approaches
32. Price Skimming
33. Penetration Pricing
34. Status Quo Pricing
LO8 Identify the legal constraints on pricing
decisions
19-8 The Legality of Price Strategy
35. Legality of Price Strategy
36. Illegal Pricing Strategies
37. Unfair Trade Practices, Price Fixing,
and Predatory Pricing
38. Robinson-Patman Act of 1936
39. Robinson-Patman Act of 1936
(continued)
Chapter 19: Pricing Concepts
7
Learning Outcomes and Topics
PowerPoint Slides
LO9 Explain how discounts, geographic
pricing, and other pricing tactics can be
used to fine-tune a base price
19-9 Tactics for Fine-Tuning the Base Price
40. Tactics for Fine-Tuning the Bae Price
41. Tactics for Fine-Tuning the Bae Price
42. Discounts, Allowances, Rebates, and
Value-Based Pricing Tactics
43. Discounts, Allowances, Rebates, and
Value-Based Pricing Tactics (continued
1)
44. Methods of Geographic Pricing
45. Other Pricing Tactics
46. Consumer Penalty
47. Key Terms
48. Key Terms
49. Key Terms
50. Summary
51. Summary
Suggested Homework
• The end of this chapter contains assignments on the Ski Butternut video.
• This chapter’s online study tools include flashcards, visual summaries, practice quizzes,
and other resources that can be assigned or used as the basis for longer investigations into
marketing.
Lesson Plan for Video
Company Clips
Segment Summary: Ski Butternut
Ski Butternut is a ski mountain in the Berkshires dedicated to offering a great family ski value. In
this video, Matt Sawyer discusses the various ways that Ski Butternut uses pricing to drive new
business and local business to the mountain. He also discusses how correct pricing can help the
next year’s business model through season pass sales.
These teaching notes combine activities that you can assign students to prepare before class, that
you can do in class before watching the video, that you can do in class while watching the video,
and that you can assign students to complete as assignments after watching the video in class.
During the viewing portion of the teaching notes, stop the video periodically where appropriate
Chapter 19: Pricing Concepts
8
to ask students the questions or perform the activities listed on the grid. You may even want to
give the students the questions before starting the video and have them think about the answer
while viewing the segment. That way, students will be engaged in active rather than passive
viewing.
Pre-Class Prep For You
Pre-Class Prep For Your Students
• Preview the Company Clips video
segment for Chapter 19. This exercise
reviews concepts for LO1–LO6.
• Review your lesson plan.
• Make sure you have all of the equipment
needed to show the video to the class,
including the DVD and a way to project the
video.
• You can also stream the video HERE.
• Have students review and familiarize
themselves with the following terms and
concepts: importance of pricing decisions,
pricing objectives, demand determinant of
price, and cost determinant of price.
• Have students bring written definitions of
the above terms or concepts to class.
• Ask students to visit
http://www.skibutternut.com/ and review its
current pricing.
Video Review Exercise
Activity
Warm Up
Briefly discuss students’ findings from the Pre-Class Prep activity about the Ski
Butternut website. Was pricing straightforward and easy to understand? Who is
the target market?
In-Class
Preview
• Discuss pricing objectives with the class. Highlight the concepts of profit
maximization, target ROI, and sales maximization.
• Discuss demand determinants of price with the class. Point out how demand
and supply work together to determine price, the elasticity of demand, and
how yield management systems work.
• Have copies of the Company Clips questions (below) available for students
to take notes on while viewing the video segment.
Viewing
(solutions
below)
1. How do the product, place, and promotion elements of Ski Butternut’s
marketing mix influence the pricing strategy the company has chosen?
2. Would you expect demand for Ski Butternut lift tickets to be elastic? Why, or
why not?
3. What role do the product life cycle, competition, and perceptions of quality
play in Ski Butternut’s pricing?
Chapter 19: Pricing Concepts
9
Follow-up
• Divide students into groups of three to five and have them figure out a way
to apply a yield management system (YMS) to Ski Butternut’s business
model. Give them about five to ten minutes to come up with a solution, and,
time permitting, have them share their ideas with the class.
• What type of pricing strategy does Ski Butternut employ?
Solutions for Viewing Activities
1. How do the product, place, and promotion elements of Ski Butternut’s marketing mix
influence the pricing strategy the company has chosen?
Ski Butternut offers rentals, lift tickets, and classes on its beginner-level mountain, which
2. Would you expect demand for Ski Butternut lift tickets to be elastic? Why, or why
not?
3. What role do the product life cycle, competition, and perceptions of quality play in
Ski Butternut’s pricing?
Product life cycle (PLC) plays less of a role in Butternut’s pricing. Skiing is a very mature
Lesson Plan for Group Work
Class Activity 1: Retail Price Comparison
To demonstrate to students the wide variation in pricing of an identical item, ask them to visit
three different stores and compare prices on similar items.
Chapter 19: Pricing Concepts
10
First, each student should select a category of store. Given below are some of the suggestions.
• Grocery: large chain store, local chain store, convenience store
• Health and beauty aids: grocery store, drugstore, discount store
• Over-the-counter drugs: chain drugstore, local drugstore, discount store
• Clothing: specialty store, department store, discount store
A student who chooses to investigate clothing stores could compare the price of Levi’s 501 jeans
for men at the three different types of stores. A student who chooses health and beauty aids could
compare the price of a certain brand of shampoo (same size, weight, and so on) at the three
stores. Students may come up with other categories and items of interest.
If possible, each student should select several items to compare in his or her category. For
example, in the grocery category, a student may want to compare a type of cereal, a canned soup,
and a snack item.
Students who travel home every weekend may want to compare prices between towns, which is
also a very interesting exercise.
After the investigation, ask students what factors they believe lead to the variations in prices. Is it
worthwhile for consumers to compare prices when they shop?
This assignment can lead to a very interesting discussion of price competition, non-price
competition, odd–even pricing, promotional pricing, price lining, and unit pricing.
Class Activity 2: Pricing Strategies
The goal of this exercise is to make students aware of pricing strategies used by the airline
industry.
• Have your students collect price quotes for airline tickets to a city with departure dates that
are less than 7, 14, and over 21 days from the present date. How do the prices differ?
• Then have them include a Saturday night stay and no Saturday night stay. How do the
prices vary now?
• Have them check the same flight schedule comparing coach, business, and first class fares.
• What kind of pricing strategy is being used?
Review and Assignments for Chapter 19
Review Questions
Chapter 19: Pricing Concepts
11
1. Why is pricing so important to the marketing manager?
2. How does price allocate goods and services?
Price sets the image of the good. In conjunction with quality, price is part of the formula
for value. Even though price is part of the determination of value, the two factors do not
3. Why do many firms not maximize profits?
One reason that firms do not maximize value is that they can only charge a price that
4. Explain the role of supply and demand in determining price.
The price that is set depends on pricing goals and the demand for the good or service, the
cost to the seller for that good or service, and other factors. Demand is the quantity of a
5. Explain the concepts of elastic and inelastic demand. Why should managers
understand these concepts?
Chapter 19: Pricing Concepts
12
Elasticity of demand refers to consumers’ responsiveness or sensitivity to changes in price.
6. Explain the relationship between supply and demand and yield management systems.
Students’ answers will vary.
7. Why are so many companies adopting yield management systems?
A yield management system (YMS) is a technique for adjusting prices so that unused
8. Why is it important for managers to understand the concept of break-even points?
Are there any drawbacks?
The advantage of break-even analysis is that a firm can quickly discover how much it must
9. Give an example of each major type of pricing objective.
Pricing objectives are commonly classified into three categories, and students are to come
up with one example of each:
10. What are the three basic defenses that a seller can use if accused under the Robinson-
Patman Act?
Chapter 19: Pricing Concepts
13
The Robinson-Patman Act provides three defenses for the seller charged with price
Application Questions
1. If a firm can increase its total revenue by raising its price, shouldn’t it?
2. Your firm has based its pricing strictly on cost in the past. As the newly hired
marketing manager, you believe this policy should change. Write the president a
memo explaining your reasons.
Although students’ answers will vary, they should address some of these points: Prices
3. Divide the class into teams of five. Each team will be assigned a different grocery
store from a different chain (an independent store is fine, too). Appoint a group
leader. The group leaders should meet as a group and pick fifteen nationally branded
grocery items. Each item should be specifically described as to brand name and size
of the package. Each team will then proceed to its assigned store and collect price
data on the fifteen items. The team should also gather price data on fifteen similar
store brands and fifteen generics, if possible. Each team should present its results to
the class and discuss why there are price variations between stores, national brands,
store brands, and generics.
As a next step, go back to your assigned store and share the overall results with the
store manager. Bring back the manager’s comments and share them with the class.
Chapter 19: Pricing Concepts
14
Results will vary by group.
4. How does the stage of a product’s life cycle affect price? Give some examples.
Demand factors and competitive conditions tend to change as a product moves through the
different stages of its life cycle. In the introduction stage, prices are typically set high
5. Go to Priceline.com. Can you research a ticket’s price before purchasing it? What
products and services are available for purchase? How comfortable are you with
naming your own price? Relate the supply and demand curves to customer-
determined pricing.
Students’ answers will vary as to their comfort with naming their own price. Periodically,
6. You are contemplating a price change for an established product sold by your firm.
Write a memo analyzing the factors you need to consider in your decision.
Although students’ answers will vary, they should address some of these points: Before
7. Develop a price line strategy for each of these firms: a) a college bookstore, b) a
restaurant, c) a video-rental firm.
Chapter 19: Pricing Concepts
15
Product line pricing is setting prices for an entire line of products, which is a broader
8. The U.S. Postal Service regularly raises the price of a first-class stamp but continues
to operate in the red year after year. Is uniform delivered pricing the best choice for
first-class mail?
Students’ responses will vary. In general, it would seem more lucrative for the United
Application Exercise
Reliance on price as a predictor of quality seems to occur for all products. Does this mean that
high-priced products are superior? Well, sometimes. Price can be a good predictor of quality for
some products, but for others, price is not always the best way to determine the quality of a
product or service before buying it. This exercise (and worksheet) will help you examine the
price–quality relationship for a simple product: canned goods.
Activities
1. Take a trip to a local supermarket where you are certain to find multiple brands of canned
fruits and vegetables. Pick a single type of vegetable or fruit you like, such as cream corn
or peach halves, and list five or six brands in the worksheet on the following page.
Price
1
2
3
4
5
6
7
Brand
Quality
Rank
(y)
Price/
Weight
Price per
Ounce
Price Rank
(x)
d
(y-x)
d2
Chapter 19: Pricing Concepts
16
TOTAL
2. Before going any further, rank the brands according to which you think is the highest
quality (1) to the lowest quality (5 or 6, depending on how many brands you find). This
ranking will be y.
3. Record the price and the volume of each brand. For example, if a 14-ounce can costs $.89,
you would list $.89/14 oz.
4. Translate the price per volume into price per ounce. Our 14-ounce can costs $.064 per
ounce.
5. Now rank the price per ounce (we’ll call it x) from the highest (1) to the lowest (5 or 6,
again depending on how many brands you have).
6. We’ll now begin calculating the coefficient of correlation between the price and quality
rankings. The first step is to subtract x from y. Enter the result, d, in column 6.
7. Now calculate d2 and enter the value in column 7. Write the sum of all the entries in
column 7 in the final row.
8. The formula for calculating a price–quality coefficient r is as follows:
rs=1 – 6∑ d2
(n3 – n)
In the formula, rs is the coefficient of correlation, 6 is a constant, and n is the number of
items ranked.
9. What does the result of your calculation tell you about the correlation between the price
and the quality of the canned vegetable or fruit you selected? Now that you know this, will
it change your buying habits?
Purpose: To have students investigate the relationship between price and quality and perceptions
of quality
Setting It Up: This exercise requires algebra to calculate the price–quality coefficient. You can
assign this as an individual or group project.
Chapter 19: Pricing Concepts
17
This exercise was inspired by the following Great Idea in Teaching Marketing:
Vaughn C. Judd, Auburn University Montgomery
Analyzing The Price–Quality Relationship
The relationship between product price and quality is more relevant to students when they
analyze it using third-party data. Food product ratings in Cook’s Illustrated magazine provide the
data for the analyses. Consumer Reports, however, can be used as a data source if Cook’s
Illustrated is not readily available. The Spearman rank correlation coefficient, an easy statistic to
calculate in class with a hand-held calculator, is used to measure the relationship.
An Example of the Process
Step 1: Students are grouped in teams of two or three. Each team is given a reprint of a different
food review from Cook’s Illustrated magazine and a worksheet that is equivalent in form to
Table 1, but with only the column headings.
Step 2: The example, Table 1, is based on ratings of six brands of canned red kidney beans.
Students list the brands in column 1 and the rank order of quality in column 2—the best quality
being ranked number one. Although there are no ties in quality ranks in this example, brands are
sometimes tied.
Step 3: Students then list the price and volume of each brand in column 3. Since the cans contain
different volumes, the prices from column 3 are converted to per ounce equivalents in column 4.
The prices shown in column 4 are ranked from highest to lowest (1 = highest) in column 5. Note
that there are two brands with identical prices—at $.030/ounce. Using the midrank method for
handling ties, these brands are each ranked 5.5.
Step 4: Students next calculate the coefficient of correlation between the quality and price
rankings. First, they complete the d (difference) column by subtracting the x rank from the y rank
for each brand, then the d2 column by squaring the values in the d column and summing them up.
Finally, the coefficient of correlation is calculated.
Step 5: Each group is asked to draw conclusions regarding the relationship between price and
quality for the brands analyzed and to report the conclusions to the class. The conclusions, based
on the coefficients, are noted on the chalkboard. Also, they are asked how successful a consumer
would be in obtaining quality by picking the highest- or lowest-priced brands. With regard to
canned red kidney beans, there is a strong association between quality and price. Unfortunately
for consumers, the relationship is in the wrong direction as expressed by the –.90 coefficient.
Chapter 19: Pricing Concepts
18
Also, out of the six brands evaluated, the highest-priced brand ranked last in quality.
Table 1 Canned Red Kidney Beans
(1)
Brand
(2)
Quality
Rank
Price
(6)
d
(y–x)
(7)
d2
(3)
Price/Wt.
(4)
*Price per
U
(5)
Price Rank
Green
Giant
1
$.59/15.5
oz.
$.038
5.5
–4.5
20.25
Goya
2
$.59/15.5oz.
$.038
5.5
–3.5
12.25
S&W
3
$1.09/15 oz.
$.073
3
0
0
Progresso
4
$.89/19 oz.
$.047
4
0
0
Westbrae
5
$1.59/15 oz.
$.106
2
3.0
9.00
Eden
6
$1.99/15oz.
$.133
1
5.0
25.0
TOTAL
66.5
Source: Cook’s Illustrated (September/October 1997)
*Converted to a per/ounce basis
The formula for calculating Spearman’s rho is given below:
rs = 1 – 6d2
(n3 – n)
Where rs= Spearman rank order correlation, d = difference in rank in the paired rankings, n =
number of items ranked, and 6 = a constant in the formula.
Calculation:
rs = 1 – 6(66.5)/(63 - 6)
rs = l – (1.90)
rs = –.90
Conclusion
Discovering on one’s own is an important element of learning. This exercise provides that
opportunity. Students sharing their discoveries with their fellow classmates further complement
the learning process. Finally, from the shared findings there is an opportunity to generalize about
the price–quality relationship. Obviously the results will vary depending on the product
categories assigned. With regard to food products, however, experience has shown that there
tends to be low levels of correlation between price and quality.
Chapter 19: Pricing Concepts
19
Ethics Exercise
Advanced Bio Medics (ABM) has invented a new stem cell–based drug that will arrest even
advanced forms of lung cancer. Development costs were actually quite low because the drug was
an accidental discovery by scientists working on a different project. To stop the disease requires
a regimen of one pill per week for 20 weeks. There is no substitute offered by competitors. ABM
is thinking that it could maximize its profits by charging $10,000 per pill. Of course, many
people will die because they can’t afford the medicine at this price.
1. Should ABM maximize its profits?
Profit maximization entails setting prices so that total revenue is as large as possible
relative to total costs. It is not unethical on the face, but since ABM is in a monopoly
2. Does the AMA Statement of Ethics address this issue? Go to
http://www.marketingpower.com and review the Statement. Then write a brief
paragraph on what the AMA Statement of Ethics contains that relates to ABM’s
dilemma.
The AMA Statement of Ethics does not specifically address profit maximization in its
Video Assignment: Ski Butternut
Ski Butternut is a ski mountain in the Berkshires dedicated to offering a great family ski value. In
this video, Matt Sawyer discusses the various ways that Ski Butternut uses pricing to drive new
business and local business to the mountain. He also discusses how correct pricing can help the
next year’s business model through season pass sales.
Chapter 19: Pricing Concepts
20
1. First time skiers demonstrate elastic demand.
a. True
b. False
2. When Ski Butternut reduced the first time skier package from $135 to $75, first time
skiers:
a. experienced unitary elasticity for ski lessons.
b. saw a profit maximization scheme based on discounting the first visit and charging a
lot more once the skier is hooked.
c. saw a perceived reasonable value for an activity they haven’t tried yet.
d. bartered for lower priced rentals.
3. Knowing that weather can affect the profits for a ski area, but also that offering low prices
drives more locals to Ski Butternut, Matt Sawyer is saying that Ski Butternut is aiming for
profit maximization.
a. True
b. False
4. Moving from $199 season pass to $275 season pass was part of a trial and error of pricing
promotions for Ski Butternut. They have stayed at the $275 price point:
a. because it maximizes profits.
b. because it meets costs without exceeding the competition’s prices.
c. because it makes the cost an inconsequential part of an individual’s budget.
d. because the decline stage can cause some prices to increase.
