Chapter 16 Pricing Concepts Prepared by David Ferrell

Learning Outcomes LO 1 Discuss the importance of pricing decisions to the economy and to the individual firm LO 2 List and explain a variety of pricing objectives LO 3 Explain the role of demand in price determination LO 4 Understand the concept of yield management systems LO 5 Describe cost-oriented pricing strategies Copyright 2012 by Cengage Learning Inc. All Rights Reserved 2

Learning Outcomes LO 6 Demonstrate how the product life cycle, competition, distribution and promotion strategies, guaranteed price matching, customer demands, the Internet, and perceptions of quality can affect price LO 7 Describe the procedure for setting the right price LO 8 Identify the legal and ethical constraints on pricing decisions Copyright 2012 by Cengage Learning Inc. All Rights Reserved 3

The Importance of Price LO 1 Discuss the importance of pricing decisions to the

The Importance of Price To the seller. . . Price is revenue To the consumer. . . Price is the cost of something Price allocates resources in a free-market economy 5 Copyright 2012 by Cengage Learning Inc. All Rights Reserved

What is Price? Price is that which is given up in an exchange to

The Importance of Price to Marketing Managers Revenue - The price charged to customers multiplied by the number of units sold. Profit - Revenue minus expenses. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 7

Trends Influencing Price Flood of new products Increased availability of bargain-priced private and generic brands Price cutting as a strategy to maintain or regain market share Internet used for comparison shopping Copyright 2012 by Cengage Learning Inc. All Rights Reserved 8

LO 1 Review Learning Outcome The Importance of Pricing Decisions Price X Sales Unit = Revenue – Costs = Profit drives growth, salary increases, and corporate investment Copyright 2012 by Cengage Learning Inc. All Rights Reserved 9

Pricing Objectives LO 2 List and explain a variety of pricing objectives. Copyright 2012

Pricing Objectives Profit-Oriented Sales-Oriented Status Quo Copyright 2012 by Cengage Learning Inc. All Rights

Profit-Oriented Pricing Objectives Profit Maximization Satisfactory Profits Copyright 2012 by Cengage Learning Inc. All

Profit Maximization Setting prices so that total revenue is as large as possible relative

Return on Investment Net profit after taxes divided by total assets. ROI = Net

Sales-Oriented Pricing Objectives Market Share Sales Maximization http: //www. target. com http: //www. walmart. com http: //www. jcpenney. com Online Copyright 2012 by Cengage Learning Inc. All Rights Reserved 15

Market Share A company’s product sales as a percentage of total sales for that

Sales Maximization • Short-term objective to maximize sales • Ignores profits, competition, and the marketing environment • May be used to sell off excess inventory Copyright 2012 by Cengage Learning Inc. All Rights Reserved 17

Status Quo Pricing Objectives Maintain existing prices Meet competition’s prices Copyright 2012 by Cengage

Review Learning Outcome LO 2 Pricing Objectives Profit-Oriented Profit Maximization Satisfactory Profits Target ROI Sales-Oriented Market Share Sales Maximization Copyright 2012 by Cengage Learning Inc. All Rights Reserved Status Quo Maintain Existing Price 19

The Demand Determinant of Price LO 3 Explain the role of demand in price

The Demand Determinant of Price Demand - The quantity of a product that will be sold in the market at various prices for a specified period. Supply- The quantity of a product that will be offered to the market by a supplier at various prices for a specified period. http: //www. ubid. com Online Copyright 2012 by Cengage Learning Inc. All Rights Reserved 21

The Demand Curve Copyright 2012 by Cengage Learning Inc. All Rights Reserved

The Supply Curve Copyright 2012 by Cengage Learning Inc. All Rights Reserved

How Demand Supply Establish Price equilibrium - The price at which demand supply are equal. Elasticity of Demand Consumers’ responsiveness or sensitivity to changes in price. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 24

Price Equilibrium Copyright 2012 by Cengage Learning Inc. All Rights Reserved

Elasticity of Demand Elastic Demand § Consumers buy more or less of a product when the price changes. Inelastic Demand § An increase or decrease in price will not significantly affect demand. § An increase in sales exactly offsets a decrease in prices, and revenue is unchanged. Unitary Elasticity 26 Copyright 2012 by Cengage Learning Inc. All Rights Reserved

Elasticity of Demand Elasticity (E) = Percentage change in quantity demanded of good A Percentage change in price of good A If E is greater than 1, demand is elastic. If E is less than 1, demand is inelastic. If E is equal to 1, demand is unitary. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 27

Elasticity of Demand Price Goes. . . Revenue Goes. . . Demand is. . . Down Up Elastic Down Inelastic Up Up Inelastic Up Down Elastic Up or Down Stays the Same Unitary Elasticity Copyright 2012 by Cengage Learning Inc. All Rights Reserved 28

Elasticity of Demand Copyright 2012 by Cengage Learning Inc. All Rights Reserved

Factors that Affect Elasticity of Demand Availability of substitutes Price relative to purchasing power Product durability A product’s other uses Rate of inflation http: //www. columbiahouse. com Online Copyright 2012 by Cengage Learning Inc. All Rights Reserved 30

Creating Pricing Power Copyright 2012 by Cengage Learning Inc. All Rights Reserved

LO 3 Review Learning Outcome Role of Demand in Price Determination Copyright 2012 by

The Power of Yield Management Systems LO 4 Understand the concept of yield management

Yield Management Systems A technique for adjusting prices that uses complex mathematical software to

Yield Management Systems Discounting early purchases Limiting early sales at discounted prices Overbooking capacity

Yield Management Systems • Rental property landlords use yield management systems to raise rents at a faster pace. • The “M/PF Yield-Star Price Optimizer” is similar to pricing systems used by airlines and car-rental companies. • It uses data such as number of vacancies and forecasted market conditions to determine the optimal rent. • Tenants can also take advantage of the technology. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 36

LO 4 Review Learning Outcome Yield Management Systems Copyright 2012 by Cengage Learning Inc.

The Cost Determinant of Price LO 5 Describe cost-oriented pricing strategies. Copyright 2012 by

The Cost Determinant of Price Types of Costs Variable Cost Fixed Cost Varies with changes in level of output Does not change as level of output changes 39 Copyright 2012 by Cengage Learning Inc. All Rights Reserved

The Cost Determinant of Price Markup pricing Methods Used to Set Prices Keystoning Profit

Markup Pricing – The cost of buying the product from the producer plus amounts for profit expenses n ot otherwise accounted for. Keystoning – The practice of marking up prices by 100%, or doubling the cost. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 41

Profit Maximization – The method of setting prices that occurs when marginal revenue equals marginal cost. Marginal Revenue – The extra revenue associated with selling an extra unit of output, or the change in total revenue with a one-unit change in output. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 42

Break-Even Pricing Copyright 2012 by Cengage Learning Inc. All Rights Reserved

Break-Even Pricing Break-Even Quantity Fixed cost Contribution = = Total fixed costs Fixed cost

LO 5 Review Learning Outcome Cost-Oriented Pricing Strategies Copyright 2012 by Cengage Learning Inc.

Other Determinants of Price LO 6 Demonstrate how the product life cycle, competition, distribution and promotion strategies, guaranteed price matching, customer demands, the Internet, and perceptions of quality can affect price. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 46

Other Determinants of Price Stages of the Product Life Cycle Competition Distribution Strategy Promotion

Stages in the Product Life Cycle Introductory Stage Growth Stage Maturity Stage $ $ $ High Stable Decrease Decline Stage $ Decrease Stable High Copyright 2012 by Cengage Learning Inc. All Rights Reserved 48

The Competition • High prices may induce firms to enter the market • Competition can lead to price wars • Global competition may force firms to lower prices Copyright 2012 by Cengage Learning Inc. All Rights Reserved 49

Distribution Strategy Manufacturers • Offer a larger profit margin or trade allowance Wholesalers/Retailers § Sell against the brand § Buy gray-market goods • Use exclusive distribution • Franchising • Avoid business with pricecutting discounters • Develop brand loyalty Copyright 2012 by Cengage Learning Inc. All Rights Reserved 50

Distribution Strategy Selling Against the Brand- Stocking well-known branded items at high prices in order to sell store brands at discounted prices. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 51

The Impact of the Internet Product selection Second opinions from expert sites Shopping bots

Promotion Strategy/Price Guarantee Promotion Strategy • Price used as promotional tool • Pricing can also be a tool for trade promotions Price Guarantee • Match any competitor’s price • Signals to target market it is positioned as a lowprice dealer 53 Copyright 2012 by Cengage Learning Inc. All Rights Reserved

The Relationship of Price to Quality Prestige Pricing - Charging a high price to help promote a highquality image. http: //www. vivre. com http: //www. ashford. com Copyright 2012 by Cengage Learning Inc. All Rights Reserved Online 54

Dimensions of Quality 1. Ease of use 2. Versatility 3. Durability 4. Serviceability 5.

LO 6 Review Learning Outcome Factors Affecting Price Copyright 2012 by Cengage Learning Inc.

How to Set a Price on a Product or Service LO 7 Describe the

How to Set a Price on a Product or Service Establish pricing goals Estimate demand, costs, and profits Choose a price strategy Fine tune with pricing tactics Results lead to the right price Copyright 2012 by Cengage Learning Inc. All Rights Reserved 58

Establish Pricing Goals Profit-Oriented Sales-Oriented Status Quo Copyright 2012 by Cengage Learning Inc. All

Choose a Price Strategy - A basic, long-term pricing framework, which establishes the initial price for a product and the intended direction for price movements over the product life cycle. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 60

Choose a Price Strategy Price skimming - A firm charges a high introductory price, often coupled with heavy promotion. Penetration Pricing - A firm charges a relatively low price for a product initially as a way to reach the mass market. Status Quo Pricing - Charging a price identical to or very close to the competition’s price. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 61

Price Skimming Inelastic Demand Situations When Price Skimming Is Successful Unique Advantages/Superior Legal Protection of Product Technological Breakthrough Blocked Entry to Competitors Copyright 2012 by Cengage Learning Inc. All Rights Reserved 62

Penetration Pricing Advantages Disadvantages § § Discourages or blocks competition from market entry Boosts sales and provides large profit increases § Requires gear up for mass production § § Selling large volumes at low prices § Strategy to gain market share may fail Can justify production expansion http: //www. iflyswa. com Online Copyright 2012 by Cengage Learning Inc. All Rights Reserved 63

Status Quo Pricing Advantages Disadvantages § Simplicity § Safest route to long -term survival for small firms § Copyright 2012 by Cengage Learning Inc. All Rights Reserved Strategy may ignore demand and/or cost 64

LO 7 Review Learning Outcome Setting the Right Price Establish price goals High $ Estimate demand, costs, and profits Skimming Choose a price strategy Status quo Penetration Evaluate results Fine-tune base price Low $ Set price $x. yy Copyright 2012 by Cengage Learning Inc. All Rights Reserved 65

The Legality and Ethics of Price Strategy LO 8 Identify the legal and ethical

The Legality and Ethics of Price Strategy Unfair Trade Practices Price Fixing Price Discrimination

The Legality and Ethics of Price Strategy Unfair Trade Practices- Laws that prohibit wholesalers and retailers from selling below cost. Price Fixing- An agreement between two or more firms on the price they will charge for a product. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 68

Price Discrimination The Robinson-Patman Act of 1936: 1. There must be price discrimination. 2. Transaction must occur in interstate commerce. 3. Seller must discriminate by price among two or more purchasers. 4. Products sold must be commodities or tangible goods. 5. Products sold must be of like grade and quality. 6. There must be significant competitive injury. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 69

Price Discrimination The Robinson-Patman Act of 1936: Seller Defenses Cost Market Conditions Copyright 2012

Predatory Pricing The practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market. Copyright 2012 by Cengage Learning Inc. All Rights Reserved 71