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Chapter 14 - Arriving at the Final Price
14-1
CHAPTER CONTENTS
PAGE
POWERPOINT RESOURCES TO USE WITH LECTURES .......................................... 14-2
LEARNING OBJECTIVES (LO) ........................................................................................ 14-4
KEY TERMS .......................................................................................................................... 14-4
LECTURE NOTES
• Chapter Opener: E-books and E-conomics: A Twisted Tale of Pricing for Profit ...... 14-5
• Step 4: Select an Approximate Price Level (LO 14-1)................................................ 14-6
• Step 5: Set the List or Quoted Price (LO 14-2) .......................................................... 14-17
• Step 6: Make Special Adjustments to the List or Quoted Price (LO 14-3; LO 14-4) 14-21
APPLYING MARKETING KNOWLEDGE ..................................................................... 14-31
BUILDING YOUR MARKETING PLAN ......................................................................... 14-35
VIDEO CASE (VC)
• VC-14: Carmex [B]: Setting the Price of the Number One Lip Balm ........................ 14-36
APPENDIX D CASE (D)
• D-14: Glitzz: Devising a Pricing Strategy .................................................................. 14-39
IN-CLASS ACTIVITY (ICA)
• ICA 14-1: Extra Value Meal Bundle Pricing at McDonald’s ..................................... 14-42
CONNECT APPLICATION EXERCISES ………………………………………………11-48
• Carmex: Setting the Price of the Number One Lip Balm Video Case
• Profit-Oriented Pricing Approaches Case Analysis
• Price Adjustments Click and Drag*
• Marketing Analytics: Target return-on-investment pricing Analytics Exercise
*Note: An alternate version of each Click and Drag exercise is available in Connect for students with
accessibility needs.
Chapter 14 - Arriving at the Final Price
14-2
POWERPOINT RESOURCES TO USE WITH LECTURES
PowerPoint
Textbook Figures Slide
Figure 14-1 The six steps in setting price ......................................................................................... 14-4
Figure 14-2 Four approaches for selecting an approximate price level ............................................ 14-5
Figure 14-3 Demand curve for prestige pricing .............................................................................. 14-7
Figure 14-4 Demand curve for price lining ...................................................................................... 14-9
Figure 14-5 Results of computer spreadsheet simulation to select price to achieve a target
return on investment ................................................................................................... 14-14
Figure 14-6 Marginal analysis: Expected incremental revenue must offset incremental costs
to achieve an incremental profit ................................................................................. 14-21
Figure 14-7 Three special adjustments to list or quoted price ........................................................ 14-23
Figure 14-8 The structure of trade discounts .................................................................................. 14-25
Figure 14-9 Pricing practices affected by legal restrictions ............................................................ 14-29
Figure 14-10 Five most common deceptive pricing practices ......................................................... 14-32
Applying Marketing Metrics
Are Red Bull Prices Above, At, or Below the Market?: Price Premium Percent
[See UMD14PricePremium.xls] ....................................................................................................... 14-16
Marketing Matters and Making Responsible Decisions
Marketing Matters—Customer Value: Energizer’s Lesson in Price Perception—Value Lies in
the Eye of the Beholder ..................................................................................................................... 14-8
Making Responsible Decisions—The Ethics and Economics of Surge Pricing .............................. 14-18
Marketing Matters—Customer Value: Everyday Low Prices at the Supermarket = Everyday Low
Profits—Creating Customer Value at a Cost .................................................................................... 14-27
Chapter 14 - Arriving at the Final Price
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POWERPOINT RESOURCES TO USE WITH LECTURES
PowerPoint
Excel Spreadsheets Slide
Standard markup on cost [See CH14StandardMarkupCost.xls] ....................................................... 14-11
Standard markup on selling price [See CH14StandardMarkupSell.xls] ........................................... 14-11
Experience curve pricing [See CH14ExperienceCurve.xls] ............................................................. 14-11
Figure 14-A: Standard markup on cost [See CH14Figure14-A.xls] ................................................. 14-12
Target profit pricing [See CH14TargetProfit.xls] ............................................................................. 14-13
Target return-on-sales pricing [See CH14TargetReturnonSales.xls] ................................................ 14-13
Target return-on-investment pricing [See CH14TargetROI.xls] ...................................................... 14-13
Figure 14-5: Target return-on-investment pricing [See CH14Fig14-05.xls] .................................... 14-14
Figure 14-6: Marginal analysis [See CH14Fig14-06.xls] ................................................................. 14-21
Trade (functional) discounts [See CH14TradeDiscounts.xls] .......................................................... 14-24
Cash discounts [See CH14CashDiscounts.xls] ................................................................................. 14-24
Figure 14-8: Trade (functional) discounts [See CH14Fig14-07.xls] ................................................ 14-25
Applying Marketing Knowledge Question 3: Experience curve [See CH14AMKQ3.xls]
Applying Marketing Knowledge Question 4: Marginal analysis [See CH14AMKQ4.xls]
Applying Marketing Knowledge Question 5: Target profit [See CH14AMKQ5.xls]
Applying Marketing Knowledge Question 6: Trade discounts #1 [See CH14AMKQ6.xls]
Applying Marketing Knowledge Question 7: Trade discounts #2 [See CH14AMKQ7.xls]
Videos
14-1: Rolex Ad ................................................................................................................................... 14-6
14-2: CarMax Ad .............................................................................................................................. 14-17
14-3: Carmex [B] Video Case ......................................................................................................... 14-34
In-Class Activity (ICA)
ICA 14-1: Extra Value Meal Bundle Pricing at McDonald’s ........................................................... 14-40
Chapter 14 - Arriving at the Final Price
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LEARNING OBJECTIVES (LO)
After reading this chapter students should be able to:
LO 14-2: Recognize the major factors considered in deriving a final list or quoted price from the
approximate price level.
LO 14-3: Identify the adjustments made to the approximate price level on the basis of discounts,
allowances, and geography.
LO 14-4: Name the principal laws and regulations affecting specific pricing practices.
KEY TERMS
above-, at-, or below-market pricing
price discrimination
basing-point pricing
price fixing
bundle pricing
price lining
cost-plus pricing
price war
customary pricing
product-line pricing
dynamic pricing policy
promotional allowances
everyday low pricing (EDLP)
quantity discounts
experience curve pricing
skimming pricing
fixed-price policy
standard markup pricing
FOB origin pricing
target pricing
loss-leader pricing
target profit pricing
odd-even pricing
target return-on-investment pricing
penetration pricing
target return-on-sales pricing
predatory pricing
uniform delivered pricing
prestige pricing
yield management pricing
Chapter 14 - Arriving at the Final Price
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LECTURE NOTES
E-BOOKS AND E-CONOMICS:
A TWISTED TALE OF PRICING FOR PROFIT
Why are e-book prices set just under an even number price such as $19.99? Does a publisher
make less profit on an e-book vs. a printed book?
A. Setting the Stage with e-Readers: Amazon’s Kindle
• One of the most disruptive changes in book publishing industry has been from print to
electronic books, or e-books.
• In 2007, Amazon introduced the Kindle, followed by Barnes & Noble’s Nook
in 2009, and Apple’s iPad in 2010.
• In order for e-book readers to be successful, printed books needed to be
quickly converted to e-books.
• However, the traditional approach to print book pricing was in the way.
• Solution: Change the approach to book pricing.
B. Printed Book Pricing Practices
• Traditional pricing was based on forecasted demand; the publisher sets price to
distributor (e.g., Amazon) usually at 50 percent off suggested retail.
• Distributor could sell book to consumer at whatever price it chose.
• Publisher subtracts its unit variable costs (such as unit manufacturing), freight and
handling, and royalties (about 15 percent of price) to arrive at its unit contribution per
printed book.
• At a $20.00 retail price ($10.00 to distributor), publisher typically records $4.40 unit
contribution toward fixed costs, and produce a profit.
C. Enter e-Books
• E-reader suppliers, such as Amazon, set lower retail prices for e-books in order to
build the e-reader business.
• Amazon would price at $9.99; after paying $10.00 for it, profits suffer.
• Publishers thought low book prices would erode consumers’ perception of the value
of books, cannibalize printed books sales, and result in lower prices charge to
distributors. Neither party was a winner.
D. Pricing e-Books…Profitably
• In 2010 book publishers changed their pricing approach by setting the e-book retail
prices and paying distributors, like Amazon, Barnes & Noble, or Apple, a 30 percent
commission on every e-book sold.
• Distributors could still set their own retail prices, but with a restriction.
• Distributors could set prices below a publisher’s retail list price so long as they did
note exceed the commission received from publisher.
Chapter 14 - Arriving at the Final Price
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• Ex: A publisher’s retail list price of $20.00 could be discounted no more than $14.00.
• Amazon and Apple usually set a price with an odd-ending number such as 5, 7, or 9.
Example:
o A publisher sets retail list price for $20.00
o Distributor sets price at $14.99.
o Publisher gets 70 percent of $14.99, or $10.49, and distributor gets $4.50.
o Publisher has no unit manufacturing, freight, or handling cost, just an author
royalty that drops to about $2.62.
o Therefore, publisher’s unit contribution per e-book is $7.87 ($10.49 - $2.62)
to pay total fixed costs and record a profit.
o Remember, the publisher’s unit contribution for printed book was $4.40.
o Therefore, both e-book distributors and publishers benefit from this pricing
approach.
I. STEP 4: SELECT AN APPROXIMATE PRICE LEVEL [LO 14-1]
• [Figure 14-1] A key to a marketer’s setting a final price for a product is to find an
approximate price level to use as a reasonable starting point.
• [Figure 14-2] There are four common approaches to selecting an approximate price
level.
A. Demand-Oriented Pricing Approaches
• Demand-oriented approaches weigh factors underlying expected customer tastes
and preferences more heavily than…
• Factors such as cost, profit, and competition when selecting a price level.
1. Skimming Pricing.
a. Skimming pricing involves setting the highest initial price that customers
who really desire the product are willing to pay when introducing a new or
innovative product.
• These customers are not very price sensitive.
• Customers weigh the new product’s price and quality against the same
characteristics of substitutes.
• As consumer demand is satisfied, the firm lowers the price to attract
another, more price-sensitive segment.
• Skimming pricing gets its name from skimming successive layers of
“cream,” or customer segments, as prices are lowered in a series of steps.
b. Skimming pricing is an effective strategy when:
Chapter 14 - Arriving at the Final Price
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• Enough prospective customers are willing to buy the product at the high
initial price to make these sales profitable.
• The high initial price will not attract competitors.
• Lowering price has only a minor effect on increasing the sales volume and
reducing the unit costs.
• Customers interpret the high price as signifying high quality.
• These four conditions are most likely to exist when:
2. Penetration Pricing.
a. Penetration pricing involves setting a low initial price on a new product to
appeal immediately to the mass market—the opposite of skimming pricing.
b. The conditions favoring penetration pricing are that:
• Many segments of the market are price sensitive.
• A low initial price discourages competitors from entering the market.
• Unit production and marketing costs fall dramatically as production
volumes increase.
c. A firm using penetration pricing may:
• Maintain the initial price for a time to gain profit lost from its low
introductory level.
d. Penetration pricing may follow skimming pricing.
• A firm might initially price a product high to:
– Attract price-insensitive consumers.
3. Prestige Pricing.
a. Consumers may use price as a measure of the quality or prestige of an item so
that as price is lowered beyond some point, demand for the item actually falls.
b. Prestige pricing involves setting a high price so that quality- or status-
conscious consumers will be attracted to the product and buy it.
Chapter 14 - Arriving at the Final Price
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c. In Figure 14-3:
• The demand curve:
– Slopes downward and to the right between points A and B.
– Turns back to the left between points B and C because demand is
actually reduced between points B and C.
[Video 14-1: Rolex Ad]
d. Products with an element of prestige pricing in them:
• May sell worse at lower prices than at higher ones because…
• Buyers tend to associate a lower price with lower quality.
MARKETING MATTERS
Customer Value: Energizer’s Lesson in Price Perception—
Value Lies in the Eye of the Beholder
The commercialization of new alkaline battery technology at a price that creates value
for consumers is not always obvious or easy. Just ask the marketing executives at Energizer
about their experience with pricing Energizer Advanced Formula and Energizer e2AA
alkaline batteries.
When Duracell launched its high-performance Ultra brand with a 25 percent price
premium over standard Duracell batteries, Energizer quickly countered with its own high-
performance battery—Energizer Advanced Formula. Energizer priced its Advanced Formula
4. Price Lining.
a. Price lining involves setting the price of a line of products at a number of
different specific pricing points.
b. In Figure 14-4:
Chapter 14 - Arriving at the Final Price
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• Price lining assumes that demand is elastic at each of these price points
(e.g. $59, $79, and $99) but inelastic between them.
• In some instances:
– All the items might be purchased for the same cost…
– Then marked up at different percentages to achieve these price points
based on color, style, and expected demand.
• In other instances:
5. Odd-even pricing.
a. Involves setting prices a few dollars or cents under an even number ($899.99
vs. $900.00).
6. Target pricing.
a. Consists of estimating the price that ultimate consumers would be willing to
pay for a product…
7. Bundle Pricing.
a. Is the marketing of two or more products in a single package price.
Chapter 14 - Arriving at the Final Price
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• Provides sellers with lower marketing costs.
[ICA 14-1: Extra Value Meal Bundle Pricing at McDonald’s]
8. Yield Management Pricing.
a. Is the charging of different prices to maximize revenue for a set amount of
capacity at any given time.
LEARNING REVIEW
14-1. In pricing a new product, what circumstances might support skimming or
penetration pricing?
Answer: Skimming pricing is an effective strategy when: (1) the firm may want to
recoup the initial R&D and promotion costs in developing and promoting the product;
(2) enough prospective customers are willing to buy the product immediately at the
14-2. What is odd-even pricing?
Chapter 14 - Arriving at the Final Price
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B.Cost-Oriented Pricing Approaches
• With cost-oriented approaches, price is set by looking at the production and
marketing costs (the supply side of the pricing problem) and…
• Then adding enough to cover direct expenses, overhead, and profit.
1. Standard markup pricing.
a. Standard markup pricing involves adding a fixed percentage to the cost of all
items in a specific product class.
b. Retail store managers have such a large number of products that estimating
the demand for each product as a means of setting price is impossible.
c. This percentage markup varies depending on the type of retail store and on the
product involved.
d. High volume products usually have smaller markups than do low-volume
ones.
e. These markups must:
• Cover all expenses of the store.
• Pay for overhead costs.
• Contribute something to profits.
f. See the accompanying Excel spreadsheets below to calculate a markup or
markdown.
[See CH14StandardMarkupCost.xls]
[See CH14StandardMarkupSell.xls]
g. [Figure 14-A] Suppose a manufacturer sells a consumer appliance with the
following costs and mark-ups in the channel of distribution: Manufacturer’s
cost = $51.77; channel mark-ups = 15/20/40; MSRP to consumers = $100.
• The manufacturer’s cost for the home appliance is $51.77. Its standard
• The wholesaler’s mark-up for home appliances is 20%, the second number
in the sequence. Applying this mark-up to its cost, the wholesaler’s
Chapter 14 - Arriving at the Final Price
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• The retailer’s mark-up for home appliances is 40%, the third number in
the sequence. Applying this mark-up to its cost, the retailer’s selling price
to its customers (i.e. ultimate consumers) is $100.00:
[See CH14Fig14-A.xls]
2. Cost-plus pricing.
a. Cost-plus pricing involves summing the total unit cost of providing a product
or service and adding a specific amount to the cost to arrive at a price.
b. Cost-plus pricing assumes two forms:
• Cost-plus percentage-of-cost pricing.
– Involves adding a fixed percentage of the total unit cost.
– Is often used to price one- or few-of-a-kind items.
• Cost-plus fixed-fee pricing.
– A supplier is reimbursed for all costs, regardless of what they are.
– Allowed only a fixed fee as profit that is independent of the final cost
of the project.
c. Cost-plus pricing:
• Is the most commonly used method to set prices for business products.
• Is used by business-to-business marketers in the service sector.
d. Many advertising agencies now use this approach:
• The client agrees to pay the agency a fee based on the cost of its work …
• Plus some agreed-on profit, which is often a percentage of total cost.
3. Experience curve pricing.
a. Is a method of pricing based on the learning effect, which:
• Holds that the unit cost of many products and services declines by 10
percent to 30 percent…
• Each time a firm’s experience at producing and selling them doubles,
resulting in possible rapid price reductions.
Chapter 14 - Arriving at the Final Price
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b. This reduction is regular or predictable enough that the average cost per unit
can be mathematically estimated.
c. Because prices often follow costs with experience curve pricing, a rapid
decline in price is possible.
d. This approach complements the demand-based pricing strategy of skimming
followed by penetration pricing.
e. Consumers benefit because prices decline as cumulative sales volume grows.
[See CH14ExperienceCurve.xls]
C. Profit-Oriented Pricing Approaches
A marketer may choose to balance both revenues and costs to set price by either:
• Setting a target of a specific dollar volume of profit.
• Expressing this target profit as a percentage of sales or investment.
1. Target Profit Pricing.
a. Target profit pricing involves setting an annual target of a specific dollar
volume of profit.
b. To calculate a target profit price for a picture frame store:
UVC = $22; FC = $26,000; Target Profit = $7,000; Q = 1,000.
c. NOTE: A critical assumption is that this higher average price of a framed
d. Target profit pricing:
• Is simple.
Chapter 14 - Arriving at the Final Price
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[See CH14TargetProfit.xls]
2. Target Return-on-Sales Pricing.
a. Target return-on-sales pricing involves setting a price to achieve a profit
that is a specified percentage of the sales volume.
b. Supermarkets often use this method due to the difficulty in establishing a
benchmark of sales or investment to show how much of a firm’s effort is
needed to achieve the target.
c. To calculate a target profit price for a picture frame store:
Target Return on Sales = 20%; UVC = $22; FC = $26,000; Q = 1,250.
BEPQuantity = $30,000 ÷ $4.80
20% = (TR – TC) ÷ TR
As a check:
[See CH14TargetReturnonSales.xls]
3. Target Return-on-Investment Pricing.
Chapter 14 - Arriving at the Final Price
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a. Target return-on-investment pricing involves setting a price to achieve an
annual target return-on-investment (ROI).
b. Some large, publicly owned firms and public utilities use this method.
[See CH14TargetROI.xls]
[See CH14Fig14-05.xls]
D. Competition-Oriented Pricing Approaches
Rather than emphasize demand, cost, or profit factors, a price setter can stress what
competitors or “the market” is doing.
1. Customary pricing.
a. Involves setting a price that is dictated by tradition, a standardized channel of
distribution, or other competitive factors.
b. Example: Candy bars offered through standard vending machines have a
customary price of 75 cents to $1.
2. Above-, at-, or below-market pricing.
a. Involves setting a market price for a product or product class based on a
subjective feel for the competitors’ price or market price as the benchmark.
d. At-market pricing:
Chapter 14 - Arriving at the Final Price
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e. Below-market pricing.
• Sets a market price below the prices of nationally branded competitive
products to promote a value image among buyers.
f. Companies use a “price premium” to assess whether its products and brands
are above, at, or below the market.
3. Loss-leader pricing.
a. Involves deliberately selling a product below its customary price, not to
increase sales but to…
b. Attract customers’ attention in hopes that they will buy other products with
large markups as well.
LEARNING REVIEW
14-3. What is standard markup pricing?
14-4. What profit-based pricing approach should a manager use if she wants to reflect
the percentage of the firm’s resources used in obtaining the profit?
14-5. What is the purpose of loss-leader pricing when used by a retail firm?
Chapter 14 - Arriving at the Final Price
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APPLYING MARKETING METRICS
Are Red Bull Prices Above, At, or Below the Market?
How would you determine whether a firm’s retail prices are above, at, or below the
market? Combine two consumer market share measures to create a “price premium” display
on a marketing dashboard.
Your Challenge.
Red Bull is the leading energy-drink brand in the United States in terms of dollar
market share and unit market share. Company executives want to know whether the brand’s
price premium resulting from its brand equity has eroded due to heavy price discounting in
Your Findings.
Using 2010 energy-drink brand market share data for U.S. convenience stores, the
Red Bull price premium is 1.152, or 15.2% [(38% ÷ 33%) – 1] = 0.151. Red Bull’s price
premium based on 2009 brand market share data was 1.121, or 12.1 percent. Red Bull’s
price premium has increased relative to its competitors.
[See UMD14PricePremium.xls]
Your Actions.
Red Bull has increased its price premium while retaining its unit volume share,
which is not only favorable news for the brand but also evidence of price discounting by
II. STEP 5: SET THE LIST OR QUOTED PRICE [LO 14-2]
Other factors influence the setting of a specific list or quoted price.
A. Choose a Price Policy
Choosing a price policy is important in setting a list or quoted price.
14-18
1. Fixed-Price Policy.
a. A fixed-price policy involves setting one price for all buyers of a product or
service. Also called a one-price policy. There is no variation in price.
[Video 14-2: CarMax Ad]
c. Some retailers have married this policy with a below-market approach and sell
everything in their stores for $1 or less. Example: 99¢ Only Stores.
d. Most companies use a fixed-price policy.
2. Dynamic Pricing Policy.
a. A dynamic pricing policy involves different prices for products and services
in real time in response to supply and demand conditions. Also called a
flexible-pricing policy.
b. A dynamic pricing policy gives sellers considerable discretion in setting the
final price in light of demand, cost, and competitive factors.
Chapter 14 - Arriving at the Final Price
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MAKING RESPONSIBLE DECISIONS
Ethics: The Ethics and Economics of Surge Pricing
Uber and Lyft have changed the way local taxi service operates. Using independent
drivers and driver-owned vehicles, both companies are middlemen using digital technology
to provide on-demand transportation to consumers.
Customers complain about the practice of “surge” or “prime-time” pricing using by
these companies during peak demand times. From a classical economic perspective, these
forms of dynamic pricing make sense based on supply and demand. Critics argue that this is
flagrant price gouging. Where do you stand?
B. Consider Company, Customer, and Competitive Effects on Pricing
Three other factors affect the final list or quoted price.
1. Company Effects.
a. For a firm with multiple products:
• The price decision for a single product must consider the price of other
items in its product line or lines in its product mix.
• Products are either substitutes for one another or complement each other.
• Example: Frito-Lay.
b. Product-line pricing.
• Involves setting of prices for all items in a product line to cover the total
cost and produce a profit for the complete line, not necessarily for each
item.
• Is a marketer’s challenge when selling multiple products.
c. Product-line pricing involves determining:
• The lowest-priced product and its price.
d. The lowest- and highest-priced items in the product line play important roles.
• The highest-priced item is positioned as the premium item in terms of
quality and features.
Chapter 14 - Arriving at the Final Price
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e. Price differentials between items in a product line:
• Should make sense to customers.
2. Customer Effects.
a. In setting price, retailers weigh factors heavily that satisfy the perceptions or
expectations of consumers, such as customary prices for a variety of products.
b. Retailers:
• Should not price their brands 20 to 25 percent below manufacturers’
brands.
c. Manufacturers and wholesalers must choose prices that result in profit for
resellers in the channel to gain their cooperation and support.
3. Competitive Effects.
a. A marketer’s pricing decision is immediately apparent to most competitors,
who may retaliate with price changes of their own.
b. Marketers must anticipate potential price retaliations from competitors.
c. A price war involves successive price cutting by competitors to increase or
maintain their unit sales or market share.
• Can erupt in a variety of industries (consumer electronics to soft drinks).
d. Assuming no change in unit volume or costs, an analysis of large U.S. firms
found that a 1 percent price cut lowers a firm’s net profit by an average of 8
percent.
e. Marketers consider price cutting only when one or more conditions exist:
• The company has a cost or technological advantage over its competitors.
C. Balance Incremental Costs and Revenues
