Chapter 13 – Building the Price Foundation
13-1
CHAPTER CONTENTS
PAGE
POWERPOINT RESOURCES TO USE WITH LECTURES …………………………………… 13-2
LEARNING OBJECTIVES (LO) ……………………………………………………………………………. 13-4
KEY TERMS ………………………………………………………………………………………………………….. 13-4
LECTURE NOTES
• Chapter Opener: VIZIO Inc. – Building a Smart TV Brand at a Great Value ………… 13-5
• Nature and Importance of Price (LO 13-1) ……………………………………………………….. 13-5
• Step 1: Identify Pricing Objectives and Constraints (LO 13-2) ……………………………. 13-9
• Step 2: Estimate Demand and Revenue (LO 13-3; LO 13-4) ……………………………… 13-16
• Step 3: Determining Cost, Volume, and Profit Relationships (LO 13-5; LO 13-6) .. 13-21
APPLYING MARKETING KNOWLEDGE …………………………………………………………… 13-25
BUILDING YOUR MARKETING PLAN ………………………………………………………………. 13-29
VIDEO CASE (VC)
• VC-13: Washburn Guitars: Using Break-Even Points to Make Pricing Decisions …. 13-30
APPENDIX D CASE (D)
• D-13: Wellness Getaways, Inc.: The Challenge of Setting a Price ………………………. 13-35
IN-CLASS ACTIVITY (ICA)
• ICA 13-1: Pricing an Apple iPad Air ……………………………………………………………….. 13-39
CONNECT APPLICATION EXERCISES ………………………………………………13-46
• Final Price and Profit Equations Case Analysis
• Pricing Objectives Click and Drag*
• Price Elasticity of Demand Click and Drag*
• Washburn Guitars Video Case
*Note: An alternate version of each Click and Drag exercise is available in Connect for students with
accessibility needs.
Chapter 13 – Building the Price Foundation
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POWERPOINT RESOURCES TO USE WITH LECTURES
PowerPoint
Textbook Figures Slide
Figure 13-1 The “price” a buyer pays can take different names depending on what
is purchased ………………………………………………………………………………………………….. 13-5
Figure 13-2 The six steps in setting price …………………………………………………………………………….. 13-9
Figure 13-3 Pricing, product, and advertising strategies available to firms in four types
of competitive markets ………………………………………………………………………………….. 13-15
Figure 13-4 Demand curves for Red Baron frozen cheese pizza: movement along (A) and
shift of (B) the demand curve …………………………………………………………………………. 13-19
Figure 13-4A Demand curve under initial conditions …………………………………………………………… 13–20
Figure 13-4B Shift in the demand curve with more favorable conditions …………………………..……. 13–21
Figure 13-5 Fundamental cost concepts ……………………………………………………………………………… 13-26
Figure 13-6 Calculating a break-even analysis point for a picture frame store …………………………. 13-28
Figure 13-7 Break-even analysis chart for a picture frame store …………………………………………… 13-29
Marketing Matters
Marketing Matters—Does Spirit Airlines Engage in Value Pricing? ………………………………………… 13-7
Marketing Matters—Using Big Data to Curb Smoking …………………………………………………………. 13-23
Videos
13-1: VIZIO ……………………………………………………………………………………………………………………… 13-3
13-2: Red Baron ……………………………………………………………………………………………………………….. 13-17
13-3: Washburn Guitars Video Case …………………………………………………………………………………… 13-30
In-Class Activity (ICA)
ICA 13-1: Pricing an Apple iPad Air ……………………………………………………….………………………….. 13-36
Chapter 13 – Building the Price Foundation
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POWERPOINT RESOURCES TO USE WITH LECTURES
PowerPoint
Excel Spreadsheets Continued Slide
Applying Marketing Knowledge Question 6: Demand and total revenue curves calculations
[See CH13AMKQ6.xls]
Applying Marketing Knowledge Question 7: Break-even calculation #1
[See CH13AMKQ7.xls]
Applying Marketing Knowledge Question 8: Break-even calculation #2 and profit
[See CH13AMKQ8.xls]
Applying Marketing Knowledge Question 9a: Break-even chart table
[See CH13AMKQ9a.xls]
Applying Marketing Knowledge Question 9b: Break-even chart point calculation #3
[See CH13AMKQ9b.xls]
Appendix D Case D-13 Health Cruises break-even analysis: Question 1
[See AppD13HealthCruisesQ1.xls]
Appendix D Case D-13 Health Cruises break-even analysis: Question
[See AppD13HealthCruisesQ2.xls]
Appendix D Case D-13 Health Cruises marginal analysis: Question 3
[See AppD13HealthCruisesQ3.xls]
Chapter 13 – Building the Price Foundation
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LEARNING OBJECTIVES (LO)
After reading this chapter students should be able to:
LO 13-1: Identify the elements that make up a price.
LO 13-2: Recognize the objectives a firm has in setting prices and the constraints that restrict the
range of prices a firm can charge.
LO 13-3: Explain what a demand curve is and the role of revenues in pricing decisions.
LO 13-4: Describe what price elasticity of demand means to a manager facing a pricing
decision.
LO 13-5: Explain the role of costs in pricing decisions and describe how various combinations
of price, fixed cost, and unit variable cost affect a firm’s break-even point.
KEY TERMS
barter
pricing constraints
break-even analysis
pricing objectives
break-even chart
profit equation
break-even point (BEP)
total cost (TC)
demand curve
total revenue (TR)
demand factors
unit variable cost (UVC)
fixed cost (FC)
value
price (P)
value-pricing
price elasticity of demand
variable cost (VC)
Chapter 13 – Building the Price Foundation
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LECTURE NOTES
VIZIO, INC.—BUILDING A SMART TV BRAND AT A GREAT VALUE
• VIZIO is the largest U.S.-based TV maker.
• In 2002, William Wang:
a. Co-founded VIZIO after seeing an ad for a $10,000 flat-panel HDTV set.
b. Believed he could market affordable HDTVs to average consumers.
• VIZIO HDTV sets are sold through:
a. Mass merchandisers such as Costco, Walmart, Sam’s Club, Best Buy, and Target.
b. Amazon and other authorized online retailers.
• To make affordable “Where Vision Meets Value” HDTVs, VIZIO uses:
a. Contract manufacturers instead of investing in its own facilities.
b. Specialists in the U.S. to handle product development and marketing.
• “Consumers want to save money without sacrificing quality or technology.”
• VIZIO:
a. Has sold more than 50 million HDTVs; has the second-largest market share for
televisions and smart televisions in the United States.
b. Frequently ranked “Highest in Customer Satisfaction” with HDTVs by J.D.
Power and Associates.
[Video 13-1: VIZIO]
I. NATURE AND IMPORTANCE OF PRICE
The price paid for products and services goes by many names: tuition, rent, interest,
premiums, fees, dues, fare, salary, commission, wage, and sometimes a price.
• Pricing decisions involve carefully assessing consumer demand, revenues, fixed
costs, and variable costs before setting a final price.
• Price is unique among all marketing and operations factors—it is the place where
all other business decisions come together.
a. Customers must be willing to pay it.
b. An offering’s price must:
Chapter 13 – Building the Price Foundation
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• Generate enough sales dollars to develop, produce, and market it while…
• Earning a profit for the company.
c. Small changes in price can affect both the number of units sold and profit.
A. What Is a Price? [LO 13-1]
• Price (P) is the money or other considerations (including other products and
services) exchanged for the ownership or use of a product or service.
• Barter:
a. Is the practice of exchanging products and services for other products and
services rather than for money.
b. Accounts for billions of dollars annually in domestic and international trade
(also known as countertrade—see Chapter 7).
1. The Price Equation.
a. The amount paid for a product or service:
• Is not always the same as the list, or quoted, price…
• Because discounts, allowances, and extra fees lower the effective price.
b. Accounts for billions of dollars annually in domestic and international trade
(also known as countertrade—see Chapter 7).
c. Firms now use “special fees” and “surcharges” rather than a higher list price.
d. Buyers are more willing to pay extra fees than a higher list price so…
e. Sellers use add-on charges to have consumers pay more without raising the
list price.
f. [Figure 13-1] All of the different factors that increase or decrease the price
are put together in a “price equation”:
g. These are key factors if you want to buy a 2017 Bugatti Chiron, the world’s
fastest and most expensive “open top” production car.
[See CH13PriceEquation.xls]
[ICA 13-1: Pricing an Apple iPad]
13-7
2. Calculating a Final Price.
a. Applying the price equation shown in Figure 13-1 to your Bugatti Chiron
purchase, your final price is:
Final price = [List price] – [Allowances] + [Extra Fees]
= [$2,600,000] – [$7,000)] + [$50,000
B. Price as an Indicator of Value
• Price is often used to indicate value when it is compared with the perceived
benefits of a product or service.
• Value is the ratio of perceived benefits to price:
1. Using Value Pricing.
a. Creative marketers engage in value pricing:
• The practice of simultaneously increasing product and service benefits
while…
c. In a survey, buyers, 84 percent agreed with the statement: “The higher the
price, the higher the quality.”
d. Value:
• Involves a consumer’s judgment by regarding the worth and desirability of
a product or service…
• Relative to substitutes that satisfy the same need.
Chapter 13 – Building the Price Foundation
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MARKETING MATTERS
Customer Value: Does Spirit Airlines Engage in Value Pricing? For Some Yes, For Others
No
• U.S. Department of Transportation reports that Spirit Airline fares are, on average, 40
percent lower than other airlines.
• Passengers get a seat that will not recline.
• Passengers pay extra for boarding passes, beverages, room in overhead bins, and
assigned or aisle seat.
• Spirit engages in value pricing for those who wish to get to their destination as
cheaply as possible.
• Spirit ranks high among airlines for complaints (e.g., on-time, performance, legroom),
except on fares.
C. Price in the Marketing Mix
• Pricing has a direct effect on a firm’s profits, whose profit equation is:
Profit = Total Revenue – Total Cost
Profit = (Unit Price × Quantity Sold) – (Fixed cost + Variable cost)
• Quantity sold affects costs since the quantity sold impacts a firm’s costs due to
efficiency of production.
• [Figure 13-2] The six major steps involved in the process of setting prices are:
1. Identify pricing constraints and objectives.
2. Estimate demand and revenue.
Chapter 13 – Building the Price Foundation
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LEARNING REVIEW
13-1. What is price?
13-2. What factors impact the list price to determine the final price?
13-3. What is the profit equation?
II. STEP 1: IDENTIFY PRICING OBJECTIVES
AND CONSTRAINTS [LO 13-2]
• A marketing manager must consider the pricing objectives and constraints that will
narrow the range of choices.
• Pricing objectives frequently reflect corporate goals.
• Pricing constraints often relate to conditions existing in the marketplace.
A. Identifying Pricing Objectives
• Pricing objectives:
a. Involve specifying the role of price in an organization’s marketing and
strategic plans.
b. Are carried to lower levels in the organization, such as in setting objectives for
marketing managers responsible for an individual brand.
c. May change depending on:
• The financial position of the firm.
• The success of its products.
• The market segments it targets.
Chapter 13 – Building the Price Foundation
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• An organization may pursue six broad objectives that tie directly to the
organization’s pricing objectives.
1. Profit.
a. Three different objectives relate to a firm’s profit, which is often measured in
terms of return on investment (ROI) or return on assets (ROA).
b. Managing for long-run profits objective.
• A firm gives up immediate profit by developing quality products to
penetrate competitive markets over the long term.
• Products are priced relatively low compared to their cost to develop, but
the firm expects to make greater profits later due to its high market share.
c. Maximizing current profit objective, such as for a quarter or year.
d. Target return objective. Occurs when a firm sets a profit goal, such as
20 percent for pretax ROI.
2. Sales Revenue.
a. Another objective may be to increase sales revenue, which in turn will lead to
increases in market share and profit.
3. Market Share.
a. Market share is the ratio of the firm’s sales revenues or unit sales to those of
the industry (competitors plus the firm itself).
b. Companies often pursue a market share objective when industry sales are
relatively flat or declining.
c. Although increased market share is a primary goal of some firms, others see it
as a means to other ends—increasing sales and profits.
4. Unit volume.
a. Is the quantity produced or sold.
Chapter 13 – Building the Price Foundation
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b. Firms often sell multiple products at very different prices and need to match
the unit volume demanded by customers with price and production capacity.
c. Using unit volume as an objective can be counterproductive if a volume
objective is achieved by drastic price-cutting that drives down profit.
5. Survival.
a. In some instances, profits, sales, and market share are less important
objectives of the firm than mere survival.
B. Identifying Pricing Constraints
• Pricing constraints are factors that limit the range of prices a firm may set.
• Consumer demand for the product clearly affects the price that can be charged.
• Other constraints on price vary from factors within the organization to those
factors outside the organization (competitive and regulatory/legal).
1. Demand for the Product Class, Product, and Brand.
a. The number of potential buyers for the product class (cars), product group
(family sedans), and specific brand (Toyota Camry V6) affects the price a
seller can charge.
b. Generally, the greater the demand for a product, the higher the price that can
be set.
c. Example: NY Mets tickets prices are…
• Higher against the NY Yankees.
• Lower against the Pittsburg Pirates.
2. Newness of the Product: Stage in the Product Life Cycle.
a. The newer a product and the earlier it is in its life cycle, the higher is the price
that can usually be charged.
b. The high initial price is possible because of patents and limited competition
early in its product life cycle.
c. Sometimes—when nostalgia or fad factors come into play:
Chapter 13 – Building the Price Foundation
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• But the prices for these items can take a nosedive too when the fad is over.
3. Cost of Producing and Marketing the Product.
a. Another profit consideration for marketers is to ensure that firms in their
channels of distribution make an adequate profit.
b. Without profits for channel members, a marketer is cut off from its customers.
c. Where the $200 a customer spends for a pair of designer denim jeans goes:
4. Cost of Changing Prices and Time Period They Apply.
a. Marketers must consider the cost of changing prices and which prices apply to
which time period.
5. Single Product versus a Product Line.
a. A firm has great latitude in setting and maintaining a premium price for a
unique, introductory product.
b. Example: Apple’s iPhone was unique when introduced and could set and
maintain a premium price.
6. Type of Competitive Market.
a. The seller’s price is constrained by the type of market in which it competes,
which dramatically influences:
b. [Figure 13-3] Economists delineate four types of competitive markets.
• Pure competition.
Chapter 13 – Building the Price Foundation
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– Many sellers follow the market price for identical, commodity
products.
– Advertising only informs buyers that the seller’s product is available.
• Monopolistic competition. Many sellers compete on both price and
nonprice factors (product features and advertising).
• Oligopoly.
– The few sellers try to avoid price competition because it can lead to
disastrous price wars in which all lose money.
• Pure monopoly.
– There is no price competition.
– One seller sets the price for a unique product.
7. Competitors’ Prices and Consumers’ Awareness of Them.
a. A firm must know what specific price its present and potential competitors are
charging now or are likely to charge in the near future.
b. The firm then develops a marketing mix strategy—including setting prices—
to respond to its competitors’ prices.
c. But in recent years, the Internet has increased the number of “present and
potential competitors” exponentially for many products.
d. Competitors’ prices are important only if a prospective buyer both:
e. Price changes and price transparency through the Internet and efficient
distribution have changed the competitive rules.
f. The two dimensions of this pricing revolution are:
• Consumer-Driven Pricing Actions.
– Consumers can make more efficient buying decisions when they can
compare prices on the Internet.
– This occurs when consumers:
Chapter 13 – Building the Price Foundation
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* Go home and order it online at a lower price.
• Seller- or Retailer-Driven Pricing Actions.
– Sellers are changing their online prices faster than in the recent past.
– Example: Amazon and Dance Central 3 (DC3) Xbox video game.
* The day before Thanksgiving, Amazon sold DC3 for $49.96.
* This price was the same as Walmart but 3 cents lower than Target.
8. Legal and Ethical Considerations.
a. Setting a final price is further complicated by legal and ethical issues.
b. Five pricing practices that have received special scrutiny are described more
fully in Chapter 14.
Chapter 13 – Building the Price Foundation
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LEARNING REVIEW
13-4. What is the difference between pricing objectives and pricing constraints?
13-5. How does the type of competitive market a firm is in affect its range in setting
price?
13-6. What are examples of (a) consumer-driven and (b) seller/retailer-driven pricing
actions made possible through price transparency on the Internet?
Chapter 13 – Building the Price Foundation
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III. STEP 2: ESTIMATE DEMAND AND REVENUE [LO 13–3]
Marketing executives must translate an estimate of customer demand into estimates of
revenues the firm expects to receive.
A. Estimating Demand
• How much are consumers willing to pay for a product? That depends in part on
these factors that affect the decision:
a. Preference for a particular product compared to others.
b. Convenience of purchasing the product.
c. Money (cash/credit) available to purchase the product.
• To estimate demand for a product, a marketer must:
a. Understand what the demand curve for the product might look like.
1. The Demand Curve.
a. A demand curve is a graph that relates the quantity sold and price, showing
the maximum number of units that will be sold at a given price.
[Video 13-2: Red Baron Pizza]
b. [Figure 13-4].
• Demand curve D1 shows the demand for Red Baron frozen cheese pizza
under existing conditions in 2017.
• Note that as price falls, more people decide to buy and unit sales increase.
c. There are three other factors to consider when estimating demand.
• Consumer tastes.
– These include demographics, culture, and technology.
– Marketing research is essential to estimate demand because these
environmental forces can change quickly.
• Price and availability of similar products.
– The laws of demand apply to a firm’s competitors as well.
– As the price of substitutes (Tombstone) fall or their availability
increases, the demand for a product (Red Baron) will fall.
• Consumer income. As real consumer income increases, allowing for
inflation, demand for a product (Red Baron) also increases.
Chapter 13 – Building the Price Foundation
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• The first two factors influence what consumers want to buy, while the
third factor affects what they can buy.
d. Along with price, demand factors determine consumers’ willingness and
ability to pay for products and services.
e. It is difficult to estimate demand for new products because consumer likes and
dislikes are difficult to assess.
2. Movement Along versus Shift of a Demand Curve.
a. [Figure 13-4A] Movement along a demand curve.
• Occurs when the price is lowered and quantity demanded increases.
• Demand curve D1 shows that:
• Assumes that other demand factors (consumer tastes, price and availability
of substitutes, and consumer income) remain unchanged.
b. [Figure 13-4B] Shift in the demand curve.
• Occurs when some of the factors that affect a demand curve do change:
– An increase of advertising.
• This means that:
– More of a product class is wanted for a given price—the demand curve
shifts to the right from D1 (the blue line) to D2 (the red line).
• Now, the initial demand curve, D1 (the blue line), no longer represents
frozen cheese pizza demand.
• Instead, a new curve, D2, must be drawn. D2 (the red line) represents the
new demand for Red Baron frozen cheese pizza, which is a shift to the
right from D1 to D2.
Chapter 13 – Building the Price Foundation
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B. Price Elasticity of Demand [LO 13-4]
• With a downward-sloping demand curve, marketing managers are interested in:
a. How sensitive consumer demand is to changes in the product’s price.
b. How sensitive the firm’s revenues are to changes in the product’s price.
• Price elasticity of demand measures the percentage change in quantity
demanded relative to a percentage change in price.
[See CH13PriceElasticity.xls]
• Because quantity demanded usually decreases as price increases:
a. Price elasticity of demand is usually a negative number.
b. However, for simplicity and by convention, elasticity figures are shown as
positive numbers.
c. Price elasticity of demand assumes two forms discussed in the textbook:
elastic demand and inelastic demand.
1. Elastic Demand and Inelastic Demand.
a. Elastic demand.
• Exists when a 1 percent decrease in price produces more than a
1 percent increase in quantity demanded, increasing total revenue.
• Results in a price elasticity that is greater than 1.
b. Inelastic demand.
• Exists when a 1 percent decrease in price produces less than a 1 percent
increase in quantity demanded, which decreases total revenue.
• Results in a price elasticity that is less than 1.
Chapter 13 – Building the Price Foundation
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• Thus, a product with inelastic demand means that slight increases or
decreases in price will not significantly affect the demand, or units sold.
• The concern for marketers is that while lowering price will increase the
quantity sold, revenues will actually fall.
d. It is important that marketing managers recognize that price elasticity of
demand is not the same over all possible prices of a product.
2. How Price Elasticity Affects Marketing and Public Policy Decisions.
a. Price elasticity of demand is determined by a number of factors.
b. Price elastic factors.
• The more substitutes a product has, the more price elastic it is.
• Items that require a large cash outlay compared with a person’s disposable
income are price elastic.
• Items that are not considered necessities are price elastic.
• Examples:
– A new sweater, shirt, or blouse has many substitutes.
– Airline tickets, cars, and yachts are price elastic.
c. Price inelastic factors.
• The fewer substitutes a product has, the more price inelastic it is.
• Products considered to be necessities are price inelastic.
• Items that are not considered necessities are price elastic.
• Examples:
– Gasoline has almost no substitutes and is price inelastic.
– Open-heart surgery is price inelastic.
– Toothpaste is price inelastic, so even during recessions, it often shows
price increases on the shelves of retailers.
– Soft drinks tend to be price inelastic.
• Price elasticity is important to marketing managers and for pricing
practices involving public policy
Chapter 13 – Building the Price Foundation
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MARKETING MATTERS
Customer Value: Using Big Data to Curb Smoking: Uncovering the Price
Elasticity of Demand for Cigarettes
Price elasticity is studied to gauge consumer response to taxes and fees.
Research shows that where consumers live, their education, income, and age, can
affect price elasticity of demand.
Research shows that younger consumers were more likely to reduce the
number of cigarettes smoked when prices increase.
C. Fundamentals of Estimating Revenue
• Instead of demand curves, marketers:
a. Speak in terms of “revenues generated,” which…
b. Are the monies received by the firm for selling its products.
• Total revenue (TR).
• Is the total money received from the sale of a product.