Pricing Considerations and Approaches

Chapter 11

Objectives
Understand the internal factors affecting a firms pricing decisions. Understand the external factors affecting pricing decisions, including the impact of consumer perceptions of price and value. Be able to contrast the three general approaches to setting prices.
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c Priceline.com
Buyer-driven commerce concept offers lower prices to consumers and the ability to sell excess inventory to sellers 13.5 million user customer base Tremendous growth Most deals relate to travel or time sensitive/ perishable services Not all ventures have been profitable Some customers find it difficult to commit to purchase prior to learning details

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What is Price?
Price Has Many Names
Rent Fee Rate Commission Assessment Tuition Fare Toll Premium Retainer Bribe Salary Wage Interest Tax
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Definition
Price
The amount of money charged for a product or service, or the sum of the values that consumers exchange for the benefits of having or using the product or service.
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What is Price?
Dynamic Pricing on the Web allows SELLERS to:
Charge lower prices, reap higher margins. Monitor customer behavior and tailor offers. Change prices on the fly to adjust for changes in demand or costs. Negotiate prices in online auctions and exchanges.
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MySimon is one of several independent web sites that provides product price comparisons.

MySimon

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What is Price?
Dynamic Pricing on the Web allows BUYERS to:
Get instant price comparisons from thousands of vendors. Find and negotiate lower prices. Negotiate prices in online auctions and exchanges.
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What is Price?
Price and the Marketing Mix:
Only element to produce revenues Most flexible element Can be changed quickly

Price Competition Common Pricing Mistakes

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Figure 11-1:

Factors Affecting Price Decisions

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Factors to Consider When Setting Price

Internal Factors
Marketing objectives Marketing mix strategies Costs Organizational considerations
Market positioning influences strategy Other pricing objectives:
Survival Current profit maximization Market share leadership Product quality leadership

Not-for-profit objectives:
Partial or full cost recovery Social pricing
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Product quality leadership:

Four Seasons starts with very high quality service, then charges a price to match.

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Factors to Consider When Setting Price

Internal Factors
Marketing objectives Marketing mix strategies Costs Organizational considerations
Pricing must be carefully coordinated with the other marketing mix elements Target costing is often used to support product positioning strategies based on price Nonprice positioning can also be used
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Swatch used target costing to manage costs carefully and create a watch offering the right blend of fashion and functions at a price consumers would pay.

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Factors to Consider When Setting Price

Internal Factors
Marketing objectives Marketing mix strategies Costs Organizational considerations
Types of costs:
Variable Fixed Total costs

How costs vary at different production levels will influence price-setting Experience (learning) curve effects on price
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Figure 11-2:

Cost Per Unit at Different Production Levels

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Figure 11-3:

Cost Per Unit As a Function of Accumulated Production

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Factors to Consider When Setting Price

Internal Factors
Marketing objectives Marketing mix strategies Costs Organizational considerations
Who sets the price?
Small companies: CEO or top management Large companies: Divisional or product line managers

Price negotiation is common in industrial settings Some industries have pricing departments
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External factors must also be considered when planning pricing strategy.

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Factors to Consider When Setting Price

External Factors
Nature of market and demand Competitors costs, prices, and offers Other environmental elements
Types of markets
Pure competition Monopolistic competition Oligopolistic competition Pure monopoly

Consumer perceptions of price and value Price-demand relationship

Demand curve Price elasticity of demand
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Discussion Question
How would you characterize the type of market in terms of level of competition for the following:
Electricity and gas utilities Cable TV, Internet services Local, long-distance, wireless telephone service
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Figure 11-4:

Demand Curves

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Demand curves sometimes slope upward Gibson learned that its high-quality guitars didnt sell as well at lower prices

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Factors to Consider When Setting Price

External Factors
Nature of market and demand Competitors costs, prices, and offers Other environmental elements
Consider competitors costs, prices, and possible reactions when developing a pricing strategy Pricing strategy influences the nature of competition
Low-price low-margin strategies inhibit competition High-price high-margin strategies attract competition

Benchmarking costs against the competition is recommended

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PC marketing has become extremely price competitive. Knowledge of competitive prices, offers, and costs is key to pricing strategy.

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Factors to Consider When Setting Price

External Factors
Nature of market and demand Competitors costs, prices, and offers Other environmental elements
Economic conditions
Affect production costs Affect buyer perceptions of price and value

Reseller reactions to prices must be considered Government may limit or restrict pricing options Social considerations may be taken into account
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Figure 11-5:

Major Considerations in Setting Price

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General Pricing Approaches

Cost-Based Pricing: Cost-Plus Pricing
Adding a standard markup to cost Ignores demand and competition Popular pricing technique because:

It simplifies the pricing process Price competition may be minimized It is perceived as fairer to both buyers and sellers

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General Pricing Approaches

Cost-Based Pricing Example
Variable costs: $20
Expected sales: 100,000 units

Fixed costs: $ 500,000

Desired Sales Markup: 20%

Variable Cost + Fixed Costs/Unit Sales = Unit Cost

$20 + $500,000/100,000 = $25 per unit

Unit Cost/(1 Desired Return on Sales) = Markup Price

$25 / (1 - .20) = $31.25

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General Pricing Approaches

Cost-Based Pricing: Break-Even Analysis and Target Profit Pricing
Break-even charts show total cost and total revenues at different levels of unit volume. The intersection of the total revenue and total cost curves is the break-even point. Companies wishing to make a profit must exceed the break-even unit volume.
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Figure 11-6:

Break-Even Chart for Determining Target Price

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Discussion Question
Assume the following costs:
Fixed costs (FC): $ 500,000 Variable cost/unit (VC): $ 10.00 Recalling that BE = FC/(P-VC), calculate the break-even unit volume at selling prices of $15.00 and $20.00 per unit. How many units would need to be sold if a profit of $250,000 was desired?

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Figure 11-7:

Cost-Based Versus Value-Based Pricing

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General Pricing Approaches

Value-Based Pricing:
Uses buyers perceptions of value rather than sellers costs to set price. Measuring perceived value can be difficult. Consumer attitudes toward price and quality have shifted during the last decade.
Introduction

of less expensive versions of established brands has become common.

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Perceived value reflects more than just the functional benefits of a product. The pen at left costs $185.00

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General Pricing Approaches

Value-Based Pricing:
Business-to-business firms seek to retain pricing power

Value-added strategies can help Everyday low pricing (EDLP) vs. high-low pricing

Value pricing at the retail level

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General Pricing Approaches

Competition-Based Pricing:
Also called going-rate pricing May price at the same level, above, or below the competition Bidding for jobs is another variation of competition-based pricing

Sealed bid pricing

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BusinessNow
Metreo Video Clip
Pricing in business-tobusiness sales is often negotiable. Metreos software helps companies make pricing decisions.
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Click the picture above to play video

Transfer Pricing
The amount charged when one division sells goods or services to another division.

Batteries
Battery Division Auto Division

Transfer Pricing
The transfer price affects the profit measure for both the selling division and the buying division.
A higher transfer price for batteries means . . .

Battery Division greater profits for the battery division.

Auto Division lower profits for the auto division.

Transfer Pricing
The ideal transfer price allows each division manager to make decisions that maximize the companys profit, while attempting to maximize the divisions profit.

Setting Transfer Prices

Market-based transfer prices are preferred because they promote efficiency and When market prices are not available, fairness. companies may use . . .
Cost-based prices Negotiated prices

Negotiated Transfer Price

A system where transfer prices are arrived at through negotiation between managers of buying and selling divisions.

Excessive management time may be used in the negotiation process.

May not be in the best interest of the company.

Cost-Based Transfer Prices

Cost-based transfer prices are the least desirable because the incentive to control cost is diminished.

When used, cost-based transfer prices . . .

Are either variable cost or full cost. Should use standard rather than actual costs.

Setting Transfer Prices

Conflicts may arise between the companys interests and an individual managers interests when transfer-price-based performance measures are used.

Lets transfer some of your capital to me so that my rate of return will be higher!

End of Chapter 9