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Lamb, Hair, McDaniel

CHAPTER 19

Pricing Concepts

2010-2011

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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

Learning OutcomesLearning Outcomes

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LO 4 Understand the concept of yield management systems

LO 5 Describe cost-oriented pricing strategies

LO 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

Learning OutcomesLearning Outcomes

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Discuss the importance of pricing

decisions to the economy and to the

individual firm

The Importance of PriceThe Importance of Price

LO1

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The Importance of Price

Price allocates resources in a free-market economyPrice allocates resources in a free-market economy

To the consumer...Price is the cost

of something

To the consumer...Price is the cost

of something

To the seller...Price is revenueTo the seller...

Price is revenue

LO1

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What Is Price?

Price is that which is

given up in an

exchange to acquire a

good or service.

PricePrice

LO1

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What is Price?

• Sacrifice Effect of Price– What is sacrificed to get a good or service

• Money, Time, Dignity

• Information Effect of Price– Infer quality information based on price

• Higher quality = higher price• Convey status

• Value Based upon Perceived Satisfaction– Reasonable Price = Perceived Reasonable Value

• Exchange based on expectation of satisfaction

LO1

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Fashion’s Elite Wage War on Discounts

• Anna Wintour and Diane von Furstenburg– Fashion’s Night Out: Joint effort between 700

stores in 11 countries • Feature extended store hours and special events

– Giveaways and appearances by celebrities and designers.

– Aims to attract customers– Reverse the trend of discounting – Hope to increase consumer demand by cutting back their

orders by about 20%. – But if shoppers still won’t buy, there will be a need to offer

sales in order to move inventory

Source: Binkley, Christina. “Fashion’s Elite Wage a War on Discounts,” The Wall Street Journal, August 13, 2009, D1, D6.LO1

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The Importance of Price to Marketing Managers

RevenueRevenueThe price charged to customers multiplied by the number of units sold.

The price charged to customers multiplied by the number of units sold.

ProfitProfit Revenue minus expenses.Revenue minus expenses.

LO1

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Trends Influencing Price

Flood of new productsFlood of new products

Increased availability of bargain-priced private and generic brandsIncreased availability of bargain-priced private and generic brands

Price cutting as a strategy to maintain or regain market sharePrice cutting as a strategy to maintain or regain market share

Internet used for comparison shoppingInternet used for comparison shopping

LO1

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The Importance of Pricing Decisions

Price X Sales Unit = Revenue

Revenue – Costs = Profit

Profit drives growth, salary increases, and corporate investment

LO1

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List and explain a variety of pricing

objectives

Pricing ObjectivesPricing Objectives

LO2

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Pricing Objectives

Profit-Oriented

Sales-Oriented

Status Quo

LO2

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Profit-OrientedPricing Objectives

Profit-Oriented Pricing Objectives

ProfitMaximization

ProfitMaximization

SatisfactoryProfits

SatisfactoryProfits

Target Return on

Investment

Target Return on

Investment

LO2

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Profit Maximization

Setting prices so that total

revenue is as large as possible

relative to total costs.

Profit Maximization

Profit Maximization

LO2

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Return on Investment

ROI = Net Profit after taxes Total assets

Net profit after taxes

divided by total assets.

Return on

Investment

Return on

Investment

LO2

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Sales-OrientedPricing Objectives

MarketShare

MarketShare

SalesMaximization

SalesMaximization

Sales-Oriented Pricing Objectives

LO2

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Market Share

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

LO2

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Sales Maximization

Short-term objective to maximize sales

Ignores profits, competition, and the marketing environment

May be used to sell off excess inventory

LO2

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Status Quo Pricing Objectives

Maintainexistingprices

Maintainexistingprices

Meetcompetition’s

prices

Meetcompetition’s

prices

Status Quo Pricing Objectives

LO2

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Pricing during a Recession

Increase advertising when your competitors are cutting back to improve your market share and ROI at a lower cost.

Motivate distributors to stock your full product line: offer early-buy allowances, extended financing, and generous return policies.

Offer temporary price promotions, reduce quantity-discount thresholds, extend credit to long-standing customers, price smaller-pack sizes aggressively.

Know your cost structure to ensure that any cuts or consolidations will save money with minimum customer impact.

Source: Professor John Quelch, “Marketing Your Way Through a Recession,” Harvard Business School, Working Knowledge, March 3, 2008.LO2

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Explain the role of demand in price determination

The DemandThe DemandDeterminant of PriceDeterminant of Price

LO3

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The DemandDeterminant of Price

DemandDemandThe quantity of a product that will be sold in the market at various prices for a specified period.

The quantity of a product that will be sold in the market at various prices for a specified period.

SupplySupplyThe quantity of a product that will be offered to the market by a supplier at various prices for a specific period.

The quantity of a product that will be offered to the market by a supplier at various prices for a specific period.

LO3

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The Demand Curve

LO3

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The Supply Curve

LO3

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How Demand and Supply Establish Price

PriceEquilibrium

PriceEquilibrium

The price at which demand and supply are equal.

The price at which demand and supply are equal.

Elasticity of Demand

Elasticity of Demand

Consumers’ responsiveness or sensitivity to changes in price.

Consumers’ responsiveness or sensitivity to changes in price.

LO3

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Price Equilibrium

LO3

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Elasticity of Demand

Elastic Demand Elastic

Demand

Consumers buy more or lessof a product when the price changes.

InelasticDemand

InelasticDemand

An increase or decrease in price will not significantly affect demand.

UnitaryElasticityUnitary

Elasticity

An increase in sales exactly offsets a decrease in prices, and revenue is unchanged.

LO3

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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.

LO3

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Elasticity of DemandPrice Goes...Price Goes...Price Goes...Price Goes... Revenue Goes...Revenue Goes...Revenue Goes...Revenue Goes... Demand is...Demand is...

Down Up Elastic

Down Down Inelastic

Up Up Inelastic

Up Down Elastic

Up or Down Stays the Same Unitary Elasticity

LO3

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Elasticity of Demand

LO3

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Factors that Affect Elasticity of Demand

Availability of substitutesAvailability of substitutes

Price relative to purchasing powerPrice relative to purchasing power

Product durabilityProduct durability

A product’s other usesA product’s other uses

Rate of inflationRate of inflation

LO3

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Understand the concept of yield

management systems

The Power of Yield The Power of Yield Management SystemsManagement Systems

LO4

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Yield Management Systems

A technique for adjusting

prices that uses complex

mathematical software to

profitably fill unused

capacity.

LO4

Yield Management

Systems

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Yield Management Systems

Discounting early purchasesDiscounting early purchases

Limiting early sales at discounted pricesLimiting early sales at discounted prices

Overbooking capacityOverbooking capacity

LO4

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Yield Management Systems

Yield Management Systems (YMS) make it possible for a company to:

1. stimulate demand when

demand is low, and

2. maximize profits when demand

is high.

.

LO4

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SOURCE: “Dynamic Pricing Schemes—Established Supplier Led Pricing—Yield Management,” online at http://www.managingchange.com/hynamic/yieldmgt.htm, accessed November 7, 2007.

Yield Management SystemsSupply Side of Product or Service

LO4

High Office block

House

Airline seat

Utilities

Sport event

Rental car

Low Shirt

Pencils

Food

Tropical fish

Low High

Cap

ital In

ten

sity

Perishability

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SOURCE: “Dynamic Pricing Schemes—Established Supplier Led Pricing—Yield Management,” online at http://www.managingchange.com/hynamic/yieldmgt.htm, accessed November 7, 2007.

Yield Management Systems

Vari

ab

ilit

y o

f D

em

an

d

Demand Side of Product or Service

LO4

High Utilities

Highway use

Telephone

Airline seat

Sport event

Rental car

Mobile phone

Low Food

Music CD

Shirt

Office block

Laptop

House

Low High

Variability of Value

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Yield Management Systems

LO4

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Describe cost-oriented pricing strategies

The Cost Determinant of PriceThe Cost Determinant of Price

LO5

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The Cost Determinant of Price

Varies with changes in level of output

Varies with changes in level of output

Types of CostsTypes of Costs

VariableCost

VariableCost Fixed CostFixed Cost

Does not change as level of output changes

Does not change as level of output changes

LO5

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The Cost Determinant of Price

Break-EvenPricing

Break-EvenPricing

Profit Maximization Pricing

Profit Maximization Pricing

KeystoningKeystoning

Markup pricingMarkup pricing

MethodsUsed to

Set Prices

MethodsUsed to

Set Prices

LO5

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Markup Pricing

Markup Pricing

Markup Pricing

The cost of buying the product from the producer plus amounts for profit and for expenses not otherwise accounted for.

The cost of buying the product from the producer plus amounts for profit and for expenses not otherwise accounted for.

KeystoningKeystoning The practice of marking up prices by 100%, or doubling the cost.

The practice of marking up prices by 100%, or doubling the cost.

LO5

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Profit Maximization

ProfitMaximization

ProfitMaximization

A method of setting prices that occurs when marginal revenue equals marginal cost.

A method of setting prices that occurs when marginal revenue equals marginal cost.

MarginalRevenue

MarginalRevenue

The extra revenue associated with selling an extra unit of output, or the change in total revenue with a one-unit change in output.

The extra revenue associated with selling an extra unit of output, or the change in total revenue with a one-unit change in output.

LO5

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Break-Even Pricing

LO5

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Break-Even Pricing

Break-EvenQuantity = Total fixed costs

Fixed cost contribution

Fixed costContribution = Price - Avg. Variable Cost

LO5

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REVIEW LEARNING OUTCOMECost-Oriented Pricing

Strategies

LO5

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Demonstrate how the product life cycle, competition,

distribution and promotion strategies, customer demands, the Internet and extranets, and

perceptions of quality can affect price

Other Determinants of PriceOther Determinants of Price

LO6

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Other Determinants of Price

Perceived QualityPerceived Quality

Promotion StrategyPromotion Strategy

Distribution StrategyDistribution Strategy

CompetitionCompetition

Stages of theProduct Life Cycle

Stages of theProduct Life Cycle

LO6

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Stages in the Product Life Cycle

IntroductoryIntroductoryStageStage

GrowthGrowthStageStage

DeclineDeclineStageStage

$$

HighHigh$$

StableStable$$

DecreaseDecrease

MaturityMaturityStageStage

$$DecreaseDecrease

StableStable

HighHigh

LO6

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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

LO6

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Distribution StrategyManufacturersManufacturers Wholesalers/RetailersWholesalers/Retailers

Offer a larger profit margin or trade allowance

Use exclusive distribution

Franchising

Avoid business with price-cutting discounters

Develop brand loyalty

Sell against the brand

Buy gray-market goods

LO6

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Distribution Strategy

Stocking well-known branded items at

high prices in order to sell store brands

at discounted prices.

Selling againstthe brand

Selling againstthe brand

LO6

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The Impact of the Internet

Internet auctions Internet auctions

Shopping bots Shopping bots

Second opinions from expert sites Second opinions from expert sites

Product selection Product selection

LO6

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SOURCE: Jeffrey A. Trachtenberg, “Borders Business Plan Gets a Rewrite,” Wall Street Journal, March 22, 2007 B1Net Publisher Revenue

1998 2006$22.5 Billion $28.5 Billion

Online 13%

Schools and Libraries 24%

Book Clubs 5%

Non-bookstore Retail 18%

Traditional Retail 38%

[+ 2% direct-to-consumer sales]

Online 2%

Schools and Libraries 27%

Book Clubs 16%

Non-bookstore Retail 13%

Traditional Retail 42%

Impact of the Internet on Book Distribution

LO6

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The Relationship of Price to Quality

Charging a high price to

help promote a high-

quality image.

Prestige PricingPrestige Pricing

LO6

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Dimensions of Quality

1. Ease of use

2. Versatility

3. Durability

4. Serviceability

5. Performance

6. Prestige

LO6

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REVIEW LEARNING OUTCOMEFactors Affecting Price

Price– Convenience– Selling against the brand– Exclusive distribution

Distribution

Intranet and extranets

– Consumers use shopping for bargains– Increased competition– Internet auctions

Price used as a promotional tool

Promotionstrategy

Large customers pressure suppliers for price reductions and guaranteed margins

Demandsof large

customers

Uncertain consumers

tend to rely on price to indicate quality (“You get what you pay

for.”)

Price/qualityrelationship

– Other firms enter market – Price wars

IntroductionGrowthMaturityDecline

PLC

Competition

LO6