1. Introduction to pricing.PDF

10/26/2013 1. Introduction to Pricing 1 The definition of price Ø Within the economic context, it is usual to think of price as the amount of money we must sacrifice to acquire something we desire. Ø That is, we consider price...

10/26/2013 1. Introduction to Pricing 1 The definition of price Ø Within the economic context, it is usual to think of price as the amount of money we must sacrifice to acquire something we desire. Ø That is, we consider price as a formal ratio indicating the quantities of money (or goods and services) needed to acquire a given quantity of goods or services 2 1  10/26/2013 The definition of price Quantity of money or goods and services received by the seller Price = Quantity of money or goods and services received by the buyer 3 Pricing terms Ø Over time, many terms have evolved that are used instead of the term price. Ø We pay a postage rate to the Postal Service. qFees are paid to doctors, dentists, lawyers, architects, and consultants. qPremiums for insurance coverage qRent for apartments qTuition for education qFares for buses, taxis and airlines qTolls to cross a bridge or use a highway qAdmission to go to a movie, sporting event, concert, or museum 4 2  10/26/2013 Pricing terms qBanks may have user fees for credit charges, minimum required balances for a checking account service, rents for safety deposit boxes qIn international marketing, tariffs and duties are paid to import goods into another country q Because of this variety of terms, we often fail to recognize that setting a rent, interest rate, premium, fee, admission charge, or toll is a pricing decision exactly like setting the price of product purchased in a store. 5 Pricing objectives ØPricing objectives can be classified according to: q profitability or financial goals, qsales volume, qand competitive factors. 6 3  10/26/2013 Profitability objectives Ø As is true of most marketing objectives, pricing objectives need to be measured precisely. Ø Performance can then be compared with objectives to assess results. Ø Profitability objectives allow such assessment; they are expressed in specific dollars or as a percentage or sales. qThus a firm may seek average profits of $1.1 million for five years, or an 11 percent increase in total revenues before taxes. 7 Profitability objectives Elements of profitability: Ø Four basic elements affect the profitability of any multiproduct or multiservice organization: 1. Price per unit of each product or service offering 2. Costs: variable costs per unit of each offering, and fixed costs per period 3. Volume produced and sold of each offering 4. Monetary sales mix of the offerings sold 8 4  10/26/2013 Profitability objectives Profit maximization Ø In practice, maximum profits may be realized in different ways. Ø In some markets relatively low prices result in greater sales and higher profits. qFor example, Walmart and Kmart expect low unit profit margins because of their relatively low prices, but they attempt to maximize cumulative profits per period through high inventory turnover. Ø In other markets, relatively high prices result in slightly decreased unit sales, but high profits. qRolex seeks to maximize its profits through a strategy of relatively high prices and high unit profit margins that offset relatively low unit sales and inventory turnover. 9 Profitability objectives Profit maximization Ø Thus, depending on the market situation, maximum profits over a planning period may be obtained by either pricing the firm’s offerings relatively low or relatively high. Ø Which pricing strategy to follow given the objective of maximizing profits depends on the nature of market demand and competition. 10 5  10/26/2013 Profitability objectives Target return on investment Ø Another common pricing objective is to obtain some target percentage return on investment. Ø Return on investment (ROI) is expressed as the ratio of profits to investments. Ø An ROI objective would be specified as a specific percentage of the total capital employed. qFor example, a firm with $10 million in capital assets, seeking a 15% return on investment, would seek to achieve net contributions to profits of $1.5 million for the planning period. 11 Volume-based objectives Ø Some organizations set pricing objectives in terms of sales volume. Ø A common goal is sales growth, in which case the firm sets prices that will increase demand and therefore unit sales. Ø Other firms may seek sales maintenance, knowing that the organization may not have the resources needed to pursue sales growth. 12 6  10/26/2013 Volume-based objectives Ø Empirical evidence indicates that profitability seems to be correlated with market share. Ø However, it has not been established that market share causes profits. qRather, the ability of the firm to establish a strong presence in the market, such as a reputation for quality, leads to the ability to receive price premiums that produce relatively higher profitability. qIn general, companies attempt to achieve a higher market share by setting relatively low prices in order to increase unit sales. Such a pricing strategy must be based on a long-term view of profitability. qBy contrast, some companies achieve a strong position in selected markets by setting relatively high prices and offering high-quality products and services. 13 Competitive objectives Ø In certain situations, firms base their marketing and pricing objectives on competitive strategies, most often when they seek price stability and engage in nonprice competition. Ø In some cases, price stability leads to nonprice competition in which a firm’s strategy is advanced by other components of the marketing mix. q Although the goal is to maintain profitability through stable prices, the effort to increase sales through expensive promotion may erode that profitability. Still, the risks would be even greater if pricing were used to compete. 14 7  10/26/2013 Competitive objectives Ø In some markets, a firm may choose to price aggressively—price below competition—to take advantage of market changes: qwhen products are in early stages of the life cycle, q when markets are still growing, qand when there are opportunities to establish or gain a large market share. Ø As with any objective, this aggressiveness must be considered within the context of a longer-term perspective. 15 Establishing relevant pricing objectives ØNo single pricing objective is the best to pursue across market situations. ØTypically, firms set multiple objectives depending on the various marketing strategies that have been established. ØDo specific market situations, then suggest certain pricing objectives? 16 8  10/26/2013 Profitability objectives Ø It makes sense to use price to achieve profit objectives when: qThe firm is the low-cost supplier in the market— that is, the firm has a competitive cost advantage. qThe firm is the price leader—other sellers follow the firm’s pricing moves. qThere is an internal required rate of return for new product introductions. qThere is a short lead time for new products before competitors will likely enter the market. 17 Volume objectives Ø It makes sense to use price to achieve volume- oriented objectives when: qIt is known that the market is sensitive to relatively small price changes (price elastic). qThe firm knows it is the low-cost supplier. qCosts decline in a predictable way as cumulative volume increases. qThere is a strong “captive” aftermarket for replacement supplies. qThere is an identifiable growth market segment. qThere is little differential perceived value in the offerings of firms in the market. qThere is a desire to limit competitive entry. 18 9  10/26/2013 Competition objectives Ø It makes sense to pursue a competition- oriented objective when: qThe firm is the low-cost supplier. qThere are no perceived value differences across sellers in the minds of buyers. qMarket share could be captured by using nonprice marketing efforts. 19 Establishing relevant pricing objectives Summary ØThere is no one pricing objective that should be chosen for a specific set of market conditions. ØTrade-offs must be recognized and their implications carefully considered. Ø Furthermore, objectives may change as firms recognize changes in both their organizations and the markets they serve. 20 10