Retail Pricing Strategies PDF Textbook (March 2018)

Retail Pricing Strategies Course code: BBSSM2103 Text Book for Students (March 2018) V O C A T I O N A L D I P L O M A P R O G R A M 1|Page  Table of Contents Chapter 1: Introduction to pricing. Chapter 2: F...

Retail Pricing Strategies Course code: BBSSM2103 Text Book for Students (March 2018) V O C A T I O N A L D I P L O M A P R O G R A M 1|Page  Table of Contents Chapter 1: Introduction to pricing. Chapter 2: Factors and methods of pricing. Chapter 3: Pricing Strategies. Chapter 4: Setting the price. Chapter 5: Competitive Pricing. Chapter 6: Pricing & Trade discounts. 2|Page  Delivery Plan Contact Outcome Chapters Topics Week hour N0 covered Introduction to pricing. 1. Meaning of price. 1 2. Pricing as a marketing activity. 1 6 1 3. Pricing activities. 4. Pricing objectives. Factors & methods of Pricing. 1. Factors affecting pricing 2 2&3 12 2&3 2. Link between Price and Business Objectives 3. Methods to Price Your Product Quiz 1(10 Marks) + Correction 4 4 1-2-3 Pricing Strategies 1. New-Product Pricing Strategies 3 2. Product Mix Pricing Strategies 5&6 12 4 3. Price-Adjustment Strategies Setting the price 1. Selecting the pricing objective 2. Determining demand 4 3. Estimating costs 7&8 12 5 4. Analyzing competitors’ costs, prices & offers 5. Selecting a pricing method 6. Selecting final price Mid Semester Exam (20 Marks) + Correction 9 4 All Competitive Pricing: 1. Pricing to Meet Competition. 5 10 6 6 2. Pricing Above Competitors. 3. Pricing Below Competitors. Quiz 2(10 Marks) + Correction 11 4 All Pricing & Trade discounts. 6 1. Trade discounts. 11&12 10 7 Revision (subjective long answer type) 12 2 All 3|Page  Chapter 1: Introduction to Pricing “Anytime anything is sold, there must be a price involved.” Pricing is one of the most important strategic areas retailers use to gain market advantage. The challenge retailers face in making the right pricing decisions often stems from inaccurate, fragmented or simply too much information. To improve pricing decisions, retailers need a tool that can use relevant information from the merchandising system as well as competitive market information in order to suggest prices in line with the goals of the retailer for that type of merchandise and selling location. Users need a tool that they can easily manipulate and which promotes managing by exception. 4|Page  1. Meaning of price Price is the value placed on what is exchanged. Something of value is exchanged for satisfaction and utility, includes tangible (functional) and intangible (prestige) factors. This essential role of price in commerce is sometimes disguised by the use of traditional terms. If the product in the commercial exchange is a good, then the product’s price will most likely be called “price.” However, if the product is a service, then the product’s price may well go by one of a variety of other possible names (see Figure 1). “Price” Versus “Cost” Although a price may go by many names, one name it should not go by is cost. This is because, in this book, we will usually be taking the viewpoint of the seller. If we were taking the viewpoint of the buyer, this would not be an issue. Buyers, particularly consumers, will typically use the terms price and cost synonymously. For example, a woman could tell her friend, “The price of this sweater was only $30.” Or she could just as easily say, “This sweater cost me only $30.” However, from the viewpoint of the seller, the difference between prices and costs is quite important. A price is what a business charges, and a cost is what a business pays. Thus, a grocery manager may set a price of $3.79 for a 17-ounce box of Honey Nut Cheerios, may price large navel oranges at 3 for $1.99, or may sell ground chuck at the price of $3.49 per pound. But the manager must also attend to his costs. These costs include, for example, what he pays the wholesaler per case of Cheerios, what he pays 5|Page employees to stock it on the shelves, what he pays for the building, for heat and lights, for advertising, and so on. Figure: 1: Some terms used to mean “Price” 2. Pricing as a Marketing Activity Marketing activities are those actions an organization can take for the purpose of facilitating commercial exchanges. There are four categories of marketing activities that are particularly important, which are traditionally known as the four elements of the marketing mix: Product—designing, naming, and packaging goods and/or services that satisfy customer needs, Distribution—efforts to make the product available at the times and places that customers want, Promotion—communicating about the product and/or the organization that produces it. Pricing— determining what must be provided by a customer in return for the product if you use the term place for the activities of distribution, the four elements 6|Page of the marketing mix can be referred to as “the four Ps,” a reminder that has proved useful to generations of marketing students. Note that there is an important way in which pricing differs from the other three elements of the marketing mix. This is illustrated in Figure2. Product, distribution, and promotion are all part of the process of providing something satisfying to the customer. Product activities concern the design and packaging of the good or service itself, distribution involves getting the product to the customer, and promotion involves communicating the product’s existence and benefits to customers and potential customers. All three of these types of marketing activities contribute to the product being of value to customers. Figure 2: Pricing the value created by the other 3 marketing mix elements Product Distribution Create Value Promotion Pricing “Harvest Value” Pricing, on the other hand, is not primarily concerned with creating value. Rather, it could be said to be the marketing activity involved with capturing, or “harvesting,” (Collecting) the value created by the other types of marketing activities. In the words of Philip Kotler, “Price is the marketing- mix element that produces revenue; the others produce costs.” Because it is a marketing activity fundamentally different than the others, it is 7|Page important that the implications of pricing’s uniqueness be fully understood. This is one of the reasons that a course in pricing is an important part of a business education. 3. The pricing activity The marketing activity of capturing the value created by the other marketing activities is obviously of essential importance to a business organization. One could imagine an organization failing to carry out distribution or promotion activities and still be in business. But if there is no attention to pricing, a business organization cannot be viable. The activity of making decisions about prices consists of two general components. One component is price setting, which consists of decisions about individual prices. These decisions concern the price of a specific item to a specific customer or market in the current marketing environment or situation at hand. The other component of the pricing activity is establishing pricing policy, which involves decisions that guide and regulate the setting of individual prices. This guidance could be general, such as a “fixed-price policy,” which would require the organization to maintain fixed prices. It could also be more specific, such as indicating the situations when it would be permissible for the organization to offer volume discounts. Broadly, pricing policies are the organization’s rules that govern particular price-setting decisions. 8|Page  4. Pricing objectives Firms rely on price to cover the cost of production, to pay expenses, and to provide the profit incentive necessary to continue to operate the business. We might think of these factors as helping organizations to: (1) Survive, (2) earn a profit, (3) generate sales, (4) secure an adequate share of the market, and (5) gain an appropriate image. 1. Survival: It is apparent that most managers wish to pursue strategies that enable their organizations to continue in operation for the long term. So survival is one major objective pursued by most executives. For a commercial firm, the price paid by the buyer generates the firn1's revenue. If revenue falls below cost for a long period of time, the firm cannot survive. 2. Profit: Survival is closely linked to profitability. Making a $500,000 profit during the next year might be a pricing objective for a firm. Anything less will ensure failure. All business enterprises must earn a long-term profit. For many businesses, long-term profitability also allows the business to satisfy their most important constituents- stockholders. Lower-than-expected or no profits will drive down stock prices and may prove disastrous for the company. 3. Sales: Just as survival requires a long-term profit for a business enterprise, profit requires sales. As you will recall from earlier in the text, the task of marketing management relates to managing demand. Demand must be managed in order to regulate exchanges or sales. Thus marketing management's aim is to alter sales patterns in some desirable way. 9|Page 4. Market Share: If the sales of Safeway Supermarkets in the Dallas-Fort Worth metropolitan area account for 30% of all food sales in that area, we say that Safeway has a 30% market share. Management of all firms, large and small, are concerned. With maintaining an adequate share of the market so that their sales volume will enable the firm to survive and prosper. Again, pricing strategy is one of the tools that are significant in creating and sustaining market share. Prices must be set to attract the appropriate market segment in significant numbers. 5. Image: Price policies play an important role in affecting a firm's position of respect and esteem in its community. Price is a highly visible communicator. It must convey the message to the community that the firm offers good value, that it is fair in its dealings with the public, that it is a reliable place to patronize, and that it stands behind its products and services. 10 | P a g e  Chapter 2: factors and methods of Pricing 1. Factors affecting pricing The factors that businesses must consider in determining pricing policy can be summarized in four categories: Costs: In order to make a profit, a business should ensure that its products are priced above their total average cost. In the short-term, it may be acceptable to price below total cost if this price exceeds the marginal cost of production - so that the sale still produces a positive contribution to fixed costs. Competitors: If the business is a monopoly, it can set any price. At the other extreme, if a firm operates under conditions of perfect competition, it has no choice but to accept the market price. The reality is usually somewhere in between. In such cases, the chosen price needs to be very carefully considered relative to those of close competitors. Customers: The consideration of customer expectations about price must be addressed. Ideally, a business should attempt to quantify its demand curve to estimate what volume of sales will be achieved at given prices Business Objectives: Possible pricing objectives include: To maximize profits. To achieve a target return on investment. To achieve a target sales figure. To achieve a target market share. To match the competition, rather than lead the market. 11 | P a g e  2. Link between Price and Business Objectives The pricing objectives of businesses are generally related to satisfying one of five common strategic objectives: Objective 1: To Maximize Profits Although the ‘maximization of profits’ can have negative connotations for ‘the public’, in economic theory, one function of ‘profit’ is to attract new entrants to the market and the additional suppliers keep prices at a reasonable level. By seeking to differentiate their product from those of other suppliers, new entrants also expand the choice to consumers, and may vary prices as niche markets develop. Often the only element the marketer can change quickly in response to demand shifts. TR: total revenue. TC: total costs TR = Price * Qty Profits = TR - TC Objective 2: To Meet a Specific Target Return on Investment (or on net sales) Assuming a standard volume operation (i.e. production and sales) target pricing is concerned with determining the necessary mark-up (on cost) per unit sold, to achieve the overall target profit goal. Target return pricing is effective as an overall performance measure of the entire product line, but for individual items within the line, certain strategic pricing considerations may require the raising or lowering of the standard price. 12 | P a g e Objective 3: To Achieve a Target Sales Level Many businesses measure their success in terms of overall revenues. This is often a proxy for market share. Pricing strategies with this objective in mind usually focus on setting price that maximizes the volumes sold. Objective 4: To Maintain or Enhance Market Share As an organizational goal, the achievement of a desired share of the market is generally linked to increased profitability. An offensive market share strategy involves attaining increased market share, by lowering prices in the short term. This can lead to increased sales, which in the longer term can lead to lower costs (through benefits of scale and experience) and ultimately to higher prices due to increased volume/market share. Objective 5: To Meet or Prevent Competition Prices are set at a level that reflects the average industry price, with small adjustments made for unique features of the company’s specific product(s). Firms that adopt this objective must work ‘backwards’ from price and tailor costs to enable the desired margin to be delivered. 13 | P a g e  3. Methods to Price Your Product The pricing method you select provides direction on how to set your product price. The way you set prices in your business will change over time, for many reasons. As you learn more about your customers and competition, you may decide to change your pricing method. a) Markup pricing: The most elementary pricing method is to add a standard markup to the product’s cost. Construction companies submit job bids by estimating the total project cost and adding a standard markup for profit. Lawyers and accountants typically price by adding a standard markup on their time and costs. Suppose a toaster manufacturer has the following costs and sales expectations: The manufacturer’s unit cost is given by: Now assume the manufacturer wants to earn a 20 percent markup on sales. The manufacturer’s markup price is given by: 14 | P a g e The manufacturer will charge dealers $20 per toaster and make a profit of $4 per unit. If dealers want to earn 50 percent on their selling price, they will mark up the toaster 100 percent to $40. Markups are generally higher on seasonal items (to cover the risk of not selling), specialty items, slower- moving items, items with high storage and handling costs, and demand- inelastic items, such as prescription drugs. Does the use of standard markups make logical sense? Generally, no. Any pricing method that ignores current demand, perceived value, and competition is not likely to lead to the optimal price. Markup pricing works only if the marked-up price actually brings in the expected level of sales. Still, markup pricing remains popular. First, sellers can determine costs much more easily than they can estimate demand. By tying the price to cost, sellers simplify the pricing task. Second, where all firms in the industry use this pricing method, prices tend to be similar and price competition is minimized. Third, many people feel that cost-plus pricing is fairer to both buyers and sellers. Sellers do not take advantage of buyers when the latter’s demand becomes acute, and sellers earn a fair return on investment. 15 | P a g e b) Target return pricing: In target-return pricing, the firm determines the price that yields its target rate of return on investment. Public utilities, which need to make a fair return on investment, often use this method. Suppose the toaster manufacturer has invested $1 million in the business and wants to set a price to earn a 20 percent ROI, specifically $200,000. The target-return price is given by the following formula: The manufacturer will realize this 20 percent ROI provided its costs and estimated sales turn out to be accurate. But what if sales don’t reach 50,000 units? The manufacturer can prepare a break-even chart to learn what would happen at other sales levels. Fixed costs are $300,000 regardless sales volume. Variable costs, not shown in the figure, rise with volume. Total costs equal the sum of fixed and variable costs. The total revenue curve starts at zero and rises with each unit sold. The total revenue and total cost curves cross at 30,000 units. This is the break-even volume. We can verify it by the following formula: The manufacturer, of course, is hoping the market will buy 50,000 units at $20, in which case it earns $200,000 on its $1 million investment, but much 16 | P a g e depends on price elasticity and competitors’ prices. Unfortunately, target- return pricing tends to ignore these considerations. The manufacturer needs to consider different prices and estimate their probable impacts on sales volume and profits. The manufacturer should also search for ways to lower its fixed or variable costs, because lower costs will decrease its required break-even volume. Acer has been gaining share in the netbook market through rock-bottom prices made possible because of its bare-bones cost strategy. Acer sells only via retailers and other outlets and outsources all manufacturing and assembly, reducing its overhead to 8 percent of sales versus 14 percent at Dell and 15 percent at HP. 17 | P a g e c) Perceived value pricing An increasing number of companies now base their price on the customer’s perceived value. Perceived value is made up of a host of inputs, such as the buyer’s image of the product performance, the channel deliverables, the warranty quality, customer support, and softer attributes such as the supplier’s reputation, trustworthiness, and esteem. Companies must deliver the value promised by their value proposition, and the customer must perceive this value. Firms use the other marketing program elements, such as advertising, sales force, and the Internet, to communicate and enhance perceived value in buyers’ minds. Caterpillar uses perceived value to set prices on its construction equipment. It might price its tractor at $100,000, although a similar competitor’s tractor might be priced at $90,000. When a prospective customer asks a Caterpillar dealer why he should pay $10,000 more for the Caterpillar tractor, the dealer answers: $90,000 is the tractor’s price if it is only equivalent to the competitor’s tractor $7,000 is the price premium for Caterpillar’s superior durability $6,000 is the price premium for Caterpillar’s superior reliability $5,000 is the price premium for Caterpillar’s superior service $2,000 is the price premium for Caterpillar’s longer warranty on parts $110,000 is the normal price to cover Caterpillar’s superior value– $10,000 discount $100,000 final price The Caterpillar dealer is able to show that although the customer is asked to pay a $10,000 premium, he is actually getting $20,000 extra value! The customer chooses the Caterpillar tractor because he is convinced its lifetime operating costs will be lower. 18 | P a g e  d) Value pricing: In recent years, several companies have adopted value pricing: They win loyal customers by charging a fairly low price for a high-quality offering. Value pricing is thus not a matter of simply setting lower prices; it is a matter of reengineering the company’s operations to become a low-cost producer without sacrificing quality, to attract a large number of value conscious customers. Among the best practitioners of value pricing are IKEA, Target, and Southwest Airlines. In the early 1990s, Procter & Gamble created quite a stir when it reduced prices on supermarket staples such as Pampers and Luvs diapers, liquid Tide detergent, and Folgers coffee to value price them. To do so, P&G redesigned the way it developed, manufactured, distributed, priced, marketed, and sold products to deliver better value at every point in the supply chain.57 Its acquisition of Gillette in 2005 for $57 billion (a record five times its sales) brought another brand into its fold that has also traditionally adopted a value pricing strategy. Gillette In 2006, Gillette launched the “best shave on the planet” with the six-bladed Fusion—five blades in the front for regular shaving and one in the back for trimming—in both power and non-power versions. Gillette conducts exhaustive consumer research in designing its new products and markets aggressively to spread the word. The company spent over $1.2 billion on research and development after the Fusion’s predecessor, the Mach3, was introduced. About 9,000 men tested potential new products and preferred the new Fusion over the Mach3 by a two-to-one margin. To back the introduction, Procter & Gamble spent $200 million in the United States and over $1 billion worldwide. The payoff? Gillette enjoys enormous market leadership in the razor and blade categories, with 70 percent of the global market, and sizable price premiums. Refills for the Fusion Power cost $14 for a four pack, compared to $5.29 for a five-pack of Sensor Excel. All this adds up to significant, sustained profitability for corporate owner P&G 19 | P a g e  An important type of value pricing is everyday low pricing (EDLP). A retailer that holds to an EDLP pricing policy charges a constant low price with little or no price promotions and special sales. Constant prices eliminate week- to-week price uncertainty and the “high-low” pricing of promotion-oriented competitors. In high-low pricing, the retailer charges higher prices on an everyday basis but runs frequent promotions with prices temporarily lower than the EDLP level. These two strategies have been shown to affect consumer price judgments—deep discounts (EDLP) can lead customers to perceive lower prices over time than frequent, shallow discounts (high- low), even if the actual averages are the same. In recent years, high-low pricing has given way to EDLP at such widely different venues as Toyota Scion car dealers and upscale department stores such as Nordstrom, but the king of EDLP is surely Walmart, which practically defined the term. Except for a few sale items every month, Walmart promises everyday low prices on major brands. EDLP provides customer benefits of time and money. Toyota believes its Gen Y target dislikes haggling because it takes too long. These buyers collect a lot of information online anyway, so Toyota cut the time to sell Scions from the industry average of 4.5 hours to 45 minutes requiring fewer managers to approve negotiated prices and less advertising of sales. Some retailers base their entire marketing strategy around extreme everyday low pricing. The most important reason retailers adopt EDLP is that constant sales and promotions are costly and have eroded consumer confidence in everyday shelf prices. 20 | P a g e e) Going rate pricing: In going-rate pricing, the firm bases its price largely on competitors’ prices. In oligopolistic industries that sell a commodity such as steel, paper, or fertilizer, all firms normally charge the same price. Smaller firms “follow the leader,” changing their prices when the market leader’s prices change rather than when their own demand or costs change. Some may charge a small premium or discount, but they preserve the difference. Thus minor gasoline retailers usually charge a few cents less per gallon than the major oil companies, without letting the difference increase or decrease. Going-rate pricing is quite popular. Where costs are difficult to measure or competitive response is uncertain, firms feel the going price is a good solution because it is thought to reflect the industry’s collective wisdom. f) Auction-type pricing: Auction-type pricing is growing more popular, especially with scores of electronic marketplaces selling everything from pigs to used cars as firms dispose of excess inventories or used goods. These are the three major types of auctions and their separate pricing procedures: Auctions have one seller and many buyers. On sites such as eBay and Amazon.com, the seller puts up an item and bidders raise the offer price until the top price is reached. The highest bidder gets the item. English auctions are used today for selling antiques, cattle, real estate, and used equipment and vehicles. 21 | P a g e  Chapter 3: Pricing Strategies Good pricing strategy helps you determine the price point at which you can maximize profits on sales of your products or services. When setting prices, a business owner needs to consider a wide range of factors including production and distribution costs, competitor offerings, positioning strategies and the business’ target customer base. While customers won’t purchase goods that are priced too high, your company won’t succeed if it prices goods too low to cover all of the business’ costs. In chapter we are going to discuss various pricing strategies generally followed by companies A. New-Product Pricing Strategies Pricing strategies usually change as the product passes through its life cycle. The introductory stage is especially challenging. Companies bringing out a new product face the challenge of setting prices for the first time. They can choose between two broad strategies: market-skimming pricing and market-penetration pricing. 1. Market-skimming pricing (price skimming) Setting a high price for a new product to skim maximum revenues layer by layer from the segments willing to pay the high price; the company makes fewer but more profitable sales. Many companies that invent new products set high initial prices to “skim” revenues layer by layer from the market. Apple frequently uses this strategy, called market-skimming pricing (or price skimming). 22 | P a g e When Apple first introduced the iPhone, its initial price was as much as $599 per phone. The phones were purchased only by customers who really wanted the sleek new gadget and could afford to pay a high price for it. Six months later, Apple dropped the price to $399 for an 8GB model and $499 for the 16GB model to attract new buyers. Within a year, it dropped prices again to $199 and $299, respectively, and you can now buy an 8GB model for $99. In this way, Apple skimmed the maximum amount of revenue from the various segments of the market. Market skimming makes sense only under certain conditions. First, the product’s quality and image must support its higher price, and enough buyers must want the product at that price. Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price. 2. Market-penetration pricing Setting a low price for a new product to attract a large number of buyers and a large market share. Rather than setting a high initial price to skim off small but profitable market segments, some companies use market-penetration pricing. Companies set a low initial price to penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing companies to cut their prices even further. For example, the giant Swedish retailer IKEA used penetration pricing to boost its success in the Chinese market. 23 | P a g e When IKEA first opened stores in China in 2002, people crowded in but not to buy home furnishings. Instead, they came to take advantage of the freebies like air conditioning, clean toilets, and even decorating ideas. Chinese consumers are famously frugal. When it came time to actually buy, they shopped instead at local stores just down the street that offered knockoffs of IKEA’s designs at a fraction of the price. So to lure the finicky Chinese customers, IKEA slashed its prices in China to the lowest in the world, the opposite approach of many Western retailers there. By increasingly stocking its Chinese stores with China-made products, the retailer pushed prices on some items as low as 70 percent below prices in IKEA’s outlets outside China. The penetration pricing strategy worked. IKEA now captures a 43 percent market share of China’s fast-growing home wares market alone, and the sales of its seven mammoth Chinese stores surged 25 percent last year. The cavernous Beijing store draws nearly six million visitors annually. Weekend crowds are so big that employees need to use megaphones to keep them in control. Several conditions must be met for this low-price strategy to work. First, the market must be highly price sensitive so that a low price produces more market growth. Second, production and distribution costs must decrease as sales volume increases. Finally, the low price must help keep out the competition, and the penetration price must maintain its low price position. Otherwise, the price advantage may be only temporary. 24 | P a g e B. Product Mix Pricing Strategies The strategy for setting a product’s price often has to be changed when the product is part of a product mix. In this case, the firm looks for a set of prices that maximizes its profits on the total product mix. Pricing is difficult because the various products have related demand and costs and face different degrees of competition we now take a closer look at the five product mix pricing situations summarized in Table 5.1: product line pricing, optional product pricing, captive product pricing, by-product pricing, and product bundle pricing. Table 5.1: Product mix pricing 25 | P a g e  1. Product line pricing Setting the price steps between various products in a product line based on cost differences between the products, customer evaluations of different features, and competitors’ prices. Companies usually develop product lines rather than single products. For example, Rossignol offers seven different collections of alpine skis of all designs and sizes, at prices that range from $150 for its junior skis, such as Fun Girl, to more than $1,100 for a pair from its Radical racing collection. It also offers lines of Nordic and backcountry skis, snowboards, and ski related apparel. In product line pricing, management must determine the price steps to set between the various products in a line. The price steps should take into account cost differences between products in the line. More importantly, they should account for differences in customer perceptions of the value of different features. 2. Optional product pricing The pricing of optional or accessory products along with a main product. Many companies use optional product pricing—offering to sell optional or accessory products along with the main product. For example, a car buyer may choose to order a global positioning system (GPS) and Bluetooth wireless communication. Refrigerators come with optional ice makers. And when you order a new PC, you can select from a bewildering array of processors, hard drives, docking systems, software options, and service plans. Pricing these options is a sticky problem. Companies must decide which items to include in the base price and which to offer as options. 26 | P a g e  3. Captive product pricing Setting a price for products that must be used along with a main product, such as blades for a razor and games for a videogame console. Companies that make products that must be used along with a main product are using captive product pricing. Examples of captive products are razor blade cartridges, videogames, and printer cartridges. Producers of the main products (razors, videogame consoles, and printers) often price them low and set high markups on the supplies. For example, when Sony first introduced its PS3 videogame console, priced at $499 and $599 for the regular and premium versions, it lost as much as $306 per unit sold. Sony hoped to recoup the losses through the sales of more lucrative PS3 games. However, companies that use captive product pricing must be careful. Finding the right balance between the main product and captive product prices can be tricky. For example, despite industry-leading PS3 videogame sales, Sony has yet to earn back its losses on the PS3 console. Even more, consumers trapped into buying expensive captive products may come to resent the brand that ensnared them. 27 | P a g e  4. By-product pricing Setting a price for by-products to make the main product’s price more competitive. Producing products and services often generates byproducts. If the by- products have no value and if getting rid of them is costly, this will affect pricing of the main product. Using by-product pricing, the company seeks a market for these by-products to help offset the costs of disposing of them and help make the price of the main product more competitive. The by- products themselves can even turn out to be profitable—turning trash into cash. For example, Seattle’s Woodland Park Zoo has learned that one of its major by-products—animal poo—can be an excellent source of extra revenue. 5. Product bundle pricing Combining several products and offering the bundle at a reduced price. Using product bundle pricing, sellers often combine several products and offer the bundle at a reduced price. For example, fast-food restaurants bundle a burger, fries, and a soft drink at a “combo” price. Bath & Body Works offers “three-fer” deals on its soaps and lotions (such as three antibacterial soaps for $10). And Comcast, Time Warner, Verizon, and other telecommunications companies bundle TV service, phone service, and high- speed Internet connections at a low combined price. Price bundling can promote the sales of products consumers might not otherwise buy, but the combined price must be low enough to get them to buy the bundle. 28 | P a g e  C. Price-Adjustment Strategies Companies usually adjust their basic prices to account for various customer differences and changing situations. Here we examine the seven price adjustment strategies summarized in Table 5.2: discount and allowance pricing, segmented pricing, psychological pricing, promotional pricing, geographical pricing, dynamic pricing, and international pricing. Table 5.2 Price adjustments Strategy Description Discount & allowance Reducing prices to reward customer responses such as pricing paying early or promoting the product Adjusting prices to allow for differences in customers Segmented pricing products or locations Psychological pricing Adjusting prices for psychological effect Promotional pricing Temporarily reducing prices to increase short run sales Adjusting prices to account for the geographic location of Geographical pricing customer s Adjusting prices continually to meet the characteristics Dynamic pricing and needs of individual customers and situations International pricing Adjusting prices for international markets 29 | P a g e 1. Discount and Allowance Pricing A straight reduction in price on purchases during a stated period of time or of larger quantities. Most companies adjust their basic price to reward customers for certain responses, such as the early payment of bills, volume purchases, and off- season buying. These price adjustments— called discounts and allowances—can take many forms. The many forms of discounts include a cash discount, a price reduction to buyers who pay their bills promptly. A typical example is “2/10, net 30,” which means that although payment is due within 30 days, the buyer can deduct 2 percent if the bill is paid within 10 days. A quantity discount is a price reduction to buyers who buy large volumes. A seller offers a functional discount (also called a trade discount) to trade- channel members who perform certain functions, such as selling, storing, and record keeping. A seasonal discount is a price reduction to buyers who buy merchandise or services out of season. Allowance Promotional money paid by manufacturers to retailers in return for an agreement to feature the manufacturer’s products in some way. Allowances are another type of reduction from the list price. For example, trade-in allowances are price reductions given for turning in an old item when buying a new one. Trade in allowances are most common in the automobile industry but are also given for other durable goods. Promotional allowances are payments or price reductions to reward dealers for participating in advertising and sales support programs. 30 | P a g e  2. Segmented pricing Selling a product or service at two or more prices, where the difference in prices is not based on differences in costs. Companies will often adjust their basic prices to allow for differences in customers, products, and locations. In segmented pricing, the company sells a product or service at two or more prices, even though the difference in prices is not based on differences in costs. Segmented pricing takes several forms. Under customer-segment pricing, different customers pay different prices for the same product or service. Museums and movie theaters, for example, may charge a lower admission for students and senior citizens. Under product-form pricing, different versions of the product are priced differently but not according to differences in their costs. For instance, a one-liter bottle (about 34 ounces) of Evian mineral water may cost $1.59 at your local supermarket. But a five-ounce aerosol can of Evian Brumisateur Mineral Water Spray sells for a suggested retail price of $11.39 at beauty boutiques and spas. The water is all from the same source in the French Alps, and the aerosol packaging costs little more than the plastic bottles. Yet you pay about 5 cents an ounce for one form and $2.28 an ounce for the other. 31 | P a g e  Using location-based pricing, a company charges different prices for different locations, even though the cost of offering each location is the same. For instance, state universities charge higher tuition for out-of-state students, and theaters vary their seat prices because of audience preferences for certain locations. Tickets for a Saturday night performance of Green Day’s American Idiot on Broadway start at $32 for a seat in the rear balcony, whereas orchestra center seats go for $252. Finally, using time-based pricing, a firm varies its price by the season, the month, the day, and even the hour. Movie theaters charge matinee pricing during the daytime. Resorts give weekend and seasonal discounts. 3. Psychological pricing Pricing that considers the psychology of prices, not simply the economics; the price says something about the product. Price says something about the product. For example, many consumers use price to judge quality. A $100 bottle of perfume may contain only $3 worth of scent, but some people are willing to pay the $100 because this price indicates something special. In using psychological pricing, sellers consider the psychology of prices, not simply the economics. For example, consumers usually perceive higher- priced products as having higher quality. When they can judge the quality of a product by examining it or by calling on past experience with it, they use price less to judge quality. But when they cannot judge quality because 32 | P a g e  they lack the information or skill, price becomes an important quality signal. For example, who’s the better lawyer, one who charges $50 per hour or one who charges $500 per hour? You’d have to do a lot of digging into the respective lawyers’ credentials to answer this question objectively; even then, you might not be able to judge accurately. Most of us would simply assume that the higher-priced lawyer is better. Reference prices Prices that buyers carry in their minds and refer to when they look at a given product. Another aspect of psychological pricing is reference prices—prices that buyers carry in their minds and refer to when looking at a given product. The reference price might be formed by noting current prices, remembering past prices, or assessing the buying situation. Sellers can influence or use these consumers’ reference prices when setting price. For example, a grocery retailer might place its store brand of bran flakes and raisins cereal priced at $1.89 next to Kellogg’s Raisin Bran priced at $3.20. Or a company might offer more expensive models that don’t sell very well to make their less expensive but still high- priced models look more affordable by comparison. In the midst of the recent recession, Ralph Lauren was selling a “Ricky” alligator bag for $14,000, making its Tiffin Bag a steal at just $2,595. And Williams- Sonoma once offered a fancy bread maker for $279. Then it added a $429 model. The costly model flopped, but sales of the cheaper one doubled. 33 | P a g e  For most purchases, consumers don’t have all the skill or information they need to figure out whether they are paying a good price. They don’t have the time, ability, or inclination to research different brands or stores, compare prices, and get the best deals. Instead, they may rely on certain cues that signal whether a price is high or low. Interestingly, such pricing cues are often provided by sellers, in the form of sales signs, price-matching guarantees, loss-leader pricing, and other helpful hints. 4. Promotional pricing Temporarily pricing products below the list price, and sometimes even below cost, to increase short-run sales. With promotional pricing, companies will temporarily price their products below list price and sometimes even below cost to create buying excitement and urgency. Promotional pricing takes several forms. A seller may simply offer discounts from normal prices to increase sales and reduce inventories. Sellers also use special-event pricing in certain seasons to draw more customers. Thus, large-screen TVs and other consumer electronics are promotionally priced in November and December to attract holiday shoppers into the stores. Manufacturers sometimes offer cash rebates to consumers who buy the product from dealers within a specified time; the manufacturer sends the rebate directly to the customer. Rebates have been popular with automakers and producers of cell phones and small appliances, but they are also used with consumer packaged goods. Some manufacturers offer low interest financing, longer 34 | P a g e  warranties, or free maintenance to reduce the consumer’s “price.” This practice has become another favorite of the auto industry. Promotional pricing can be an effective means of generating sales for some companies in certain circumstances. But it can be damaging for other companies or if taken as a steady diet. 5. Geographical pricing Setting prices for customers located in different parts of the country or world. A company also must decide how to price its products for customers located in different parts of the United States or the world. Should the company risk losing the business of more-distant customers by charging them higher prices to cover the higher shipping costs? Or should the company charge all customers the same prices regardless of location? 6. Dynamic pricing Adjusting prices continually to meet the characteristics and needs of individual customers and situations. Throughout most of history, prices were set by negotiation between buyers and sellers. Fixed price policies—setting one price for all buyers—is a relatively modern idea that arose with the development of large-scale retailing at the end of the nineteenth century. Today, most prices are set this way. However, some companies are now reversing the fixed pricing trend. They are using dynamic pricing—adjusting prices continually to meet the characteristics and needs of individual customers and situations. 35 | P a g e For example, think about how the Internet has affected pricing. From the mostly fixed pricing practices of the past century, the Internet seems to be taking us back into a new age of fluid pricing. The flexibility of the Internet allows Web sellers to instantly and constantly adjust prices on a wide range of goods based on demand dynamics (sometimes called real-time pricing). 7. International Pricing Companies that market their products internationally must decide what prices to charge in the different countries in which they operate. In some cases, a company can set a uniform worldwide price. For example, Boeing sells its jetliners at about the same price everywhere, whether in the United States, Europe, or a third-world country. However, most companies adjust their prices to reflect local market conditions and cost considerations. The price that a company should charge in a specific country depends on many factors, including economic conditions, competitive situations, laws and regulations, and the development of the wholesaling and retailing system. Consumer perceptions and preferences also may vary from country to country, calling for different prices. Or the company may have different marketing objectives in various world markets, which require changes in pricing strategy. 36 | P a g e  Chapter 4: Setting the price A firm must set a price for the first time when it develops a new product, when it introduces its regular product into a new distribution channel or geographical area, and when it enters bids on new contract work. The firm must decide where to position its product on quality and price. Most markets have three to five price points or tiers. Marriott Hotels is good at developing different brands or variations of brands for different price points: Marriott Vacation Club—Vacation Villas (highest price), Marriott Marquis (high price), Marriott (high medium price), Renaissance (medium-high price), and Courtyard (medium price), and Towne Place Suites (medium-low price), and Fairfield Inn (low price). Firms devise their branding strategies to help convey the price-quality tiers of their products or services to consumers. The firm must consider many factors in setting its pricing policy. 37 | P a g e Table 4.1: Steps in setting a pricing policy Step 1: Selecting the pricing objective The company first decides where it wants to position its market offering. The clearer a firm’s objectives, the easier it is to set price. Five major objectives are: survival, maximum current profit, maximum market share, maximum market skimming, and product-quality leadership. a) Survival: Companies pursue survival as their major objective if they are plagued with overcapacity, intense competition, or changing consumer wants. As long as prices cover variable costs and some fixed costs, the company stays in business. Survival is a short-run objective; in the long run, the firm must learn how to add value or face extinction. b) Maximum current profits: Many companies try to set a price that will maximize current profits. They estimate the demand and costs 38 | P a g e  associated with alternative prices and choose the price that produces maximum current profit, cash flow, or rate of return on investment. This strategy assumes the firm knows its demand and cost functions; in reality, these are difficult to estimate. c) Maximum market share: Some companies want to maximize their market share. They believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest price, assuming the market is price sensitive. d) Product-quality leadership: A company might aim to be the product- quality leader in the market. Many brands strive to be “affordable luxuries”—products or services characterized by high levels of perceived quality, taste, and status with a price just high enough not to be out of consumers’ reach. e) Other pricing objectives: Nonprofit and public organizations may have other pricing objectives. A university aims for partial cost recovery, knowing that it must rely on private gifts and public grants to cover its remaining costs. A nonprofit hospital may aim for full cost recovery in its pricing. A nonprofit theater company may price its productions to fill the maximum number of seats. A social service agency may set a service price geared to client income. Step 2: Determining demand Each price will lead to a different level of demand and have a different impact on a company’s marketing objectives. The normally inverse relationship between price and demand is captured in a demand curve. The higher the price, the lower the demand. For prestige goods, the 39 | P a g e demand curve sometimes slopes upward. One perfume company raised its price and sold more rather than less! Some consumers take the higher price to signify a better product. However, if the price is too high, demand may fall. a) Estimating demand curves: Most companies attempt to measure their demand curves using several different methods. b) Price elasticity of demand: Marketers need to know how responsive, or elastic, demand is to a change in price. Consider the two demand curves in Figure 4.1 In demand curve In the demand curve (a), a price increase from $10 to $15 leads to a relatively small decline in demand from 105 to 100. In demand curve (b), the same price increase leads to a substantial drop in demand from 150 to 50. Figure : 4.1 Inelastic and elastic demand If demand hardly changes with a small change in price, we say the 40 | P a g e  demand is inelastic. If demand changes considerably, demand is elastic. Step 3: Estimating costs Demand sets a ceiling on the price the company can charge for its product. Costs set the floor. The company wants to charge a price that covers its cost of producing, distributing, and selling the product, including a fair return for its effort and risk. Yet when companies price products to cover their full costs, profitability isn’t always the net result. a) Types of costs and levels of production: A company’s costs take two forms, fixed and variable. Fixed costs, also known as overhead, are costs that do not vary with production level or sales revenue. A company must pay bills each month for rent, heat, interest, salaries, and so on regardless of output. Variable costs vary directly with the level of production. These costs tend to be constant per unit produced, but they’re called variable because their total varies with the number of units produced. Total costs consist of the sum of the fixed and variable costs for any given level of production. Average cost is the cost per unit at that level of production; it equals total costs divided by production. Management wants to charge a price that will at least cover the total production costs at a given level of production. To price intelligently, 41 | P a g e management needs to know how its costs vary with different levels of production. b) Target costing: Costs change with production scale and experience. They can also change as a result of a concentrated effort by designers, engineers, and purchasing agents to reduce them through target costing. Market research establishes a new product’s desired functions and the price at which it will sell, given its appeal and competitors’ prices. This price less desired profit margin leaves the target cost the marketer must achieve. Step 4: Analyzing competitors’ costs, prices, and offers: Within the range of possible prices determined by market demand and company costs, the firm must take competitors’ costs, prices, and possible price reactions into account. If the firm’s offer contains features not offered by the nearest competitor, it should evaluate their worth to the customer and add that value to the competitor’s price. If the competitor’s offer contains some features not offered by the firm, the firm should subtract their value from its own price. Now the firm can decide whether it can charge more, the same, or less than the competitor. The introduction or change of any price can provoke a response from customers, competitors, distributors, suppliers, and even government. Competitors are most likely to react when the number of firms is few, the product is homogeneous, and buyers are highly informed. 42 | P a g e Step 5: Selecting a pricing method Given the customers’ demand schedule, the cost function, and competitors’ prices, the company is now ready to select a price. Figure 4.4 summarizes the three major considerations in price setting: Costs set a floor to the price. Competitors’ prices and the price of substitutes provide an orienting point. Customers’ assessment of unique features establishes the price ceiling. Companies select a pricing method that includes one or more of these three considerations. Figure 4.4: The three Cs model of price setting Six price-setting methods: markup pricing, target-return pricing, perceived-value pricing, value pricing, going-rate pricing, and auction- type pricing. (Refer chapter-2) Step 6: Selecting final price Pricing methods narrow the range from which the company must select its final price. In selecting that price, the company must consider additional factors, including the impact of other marketing activities, company pricing policies, gain-and-risk-sharing pricing, and the impact of price on other parties. a) Impact of Other Marketing Activities: The final price must take into account the brand’s quality and advertising relative to the competition. b) Company Pricing Policies The price must be consistent with company pricing policies. Yet companies are not averse to establishing pricing penalties under certain circumstances. Airlines charge $150 to those 43 | P a g e  who change their reservations on discount tickets. Banks charge fees for too many withdrawals in a month or early withdrawal of a certificate of deposit. Dentists, hotels, car rental companies, and other service providers charge penalties for no-shows who miss appointments or reservations. Although these policies are often justifiable, marketers must use them judiciously and not unnecessarily alienate customers. c) Gain-And-Risk-Sharing Pricing Buyers may resist accepting a seller’s proposal because of a high perceived level of risk. The seller has the option of offering to absorb part or all the risk if it does not deliver the full promised value. Some recent risk-sharing applications include big computer hardware purchases and health plans for big unions. c) Impact of Price on Other Parties How will distributors and dealers feel about the contemplated price? If they don’t make enough profit, they may choose not to bring the product to market. Will the sales force be willing to sell at that price? How will competitors react? Will suppliers raise their prices when they see the company’s price? Will the government intervene and prevent this price from being charged? 44 | P a g e  Chapter 5: Competitive Pricing. Once a business decides to use price as a primary competitive strategy, there are many established tools and techniques that can be employed. The pricing process normally begins with a decision about the company's pricing approach to the market. Price is a very important decision criteria that customers use to compare alternatives. It also contributes to the company's position. In general, a business can price itself to match its competition, price higher, or price lower. Each has its pros and cons. Pricing to Meet Competition: Many organizations attempt to establish prices that, on average, are the same as those set by their more important competitors. Automobiles of the same size and having equivalent equipment tend to have similar prices. This strategy means that the organization uses price as an indicator or baseline. Quality in production, better service, creativity in advertising, or some other element of the marketing mix are used to attract customers who are interested in products in a particular price category, The keys to implementing a strategy of meeting competitive prices are an accurate definition of competition and a knowledge of competitor's prices. A maker of hand-crafted leather shoes is not in competition with mass producers. If he/she attempts to compete with mass producers on price, higher production costs will make the business unprofitable. A more realistic definition of competition for this purpose would be other makers of handcrafted leather shoes. Such a definition along with knowledge of their prices would allow a manager to 45 | P a g e put the strategy into effect. Banks shop competitive banks every day to check their prices. Pricing Above Competitors: Pricing above competitors can be rewarding to organizations, provided that the objectives of the policy are clearly understood and that the marketing mix is used to develop a strategy to enable management to implement the policy successfully. Pricing above competition generally requires a clear advantage on some non-price element of the marketing mix. In some cases, it is possible due to a high price- quality association on the part of potential buyers. But such an assumption is increasingly dangerous in today's information-rich environment. Consumer Reports and other similar publications make objective product comparisons much simpler for the consumer. There are also hundreds of dot.com companies that provide objective price comparisons. The key is to prove to customers that your product justifies a premium price. Pricing Below Competitors: While some firms are positioned to price above competition, others wish to carve out a market niche by pricing below competitors. The goal of such a policy is to realize a large sales volume through a lower price and profit margins. By controlling costs and reducing services, these firms are able to earn an acceptable profit, even though profit per unit is usually less. Such a strategy can be effective if a significant segment of the market is price-sensitive and/or the organization's cost structure is lower than competitors. Costs can be reduced by increased efficiency, economics of scale, or by reducing or eliminating such things as credit, delivery, and advertising. For example, if a firm could replace its field 46 | P a g e sales force with telemarketing or online access, this function might be performed at lower cost. Such reductions often involve some loss in effectiveness, so the tradeoff must be considered carefully. Historically, one of the worst outcomes that can result from pricing lower than a competitor is a "price war." Price wars usually occur when a business believes that price-cutting produces increased market share, but does not have a true cost advantage. Price wars are often caused by companies misreading or misunderstanding competitors. Typically, price wars are overreactions to threats that either aren't there at all or are not as big as they seem. Another possible drawback when pricing below competition is the company's inability to raise price or image. A retailer such as K-mart, known as a discount chain, found it impossible to reposition it as a provider of designer women's clothiers. Can you image Swatch selling a $3,000 watch? How can companies cope with the pressure created by reduced prices? Some are redesigning products for ease and speed of manufacturing or reducing costly features that their customers do not value. Other companies are reducing rebates and discounts in favor of stable, everyday low prices (ELP). In all cases, these companies are seeking shelter from pricing pressures that come from the discount mania that has been common in the U.S. for the last two decades. 47 | P a g e  Chapter 6: Pricing & Trade discounts The supply chain defines the channels or stages that a product passes through as it is converted from a raw material to a fin shed product purchased by the consumer. Figure.1 By the time the product is purchased by the consumer, the raw materials have been converted by the manufacturer, distributed through the wholesaler, and offered for sale by the retailer. In some supply chains, the distributor and wholesaler are separated. In other supply chains, the manufacturer also serves as the wholesaler. Within the supply chain, all of the channels must make a profit on the product to remain in business. Each channel applies a markup above its cost to buy the merchandise, which increases the price of the product. Sometimes a manufacturer or 48 | P a g e supplier sets a list price and then offers a trade discount or a series of trade discounts from that price to sell more products or to promote the product within the supply chain. Also, any of the channels within the supply chain may offer a cash discount to encourage prompt payment for the product. When the product is sold to the consumer, the regular selling price may be marked down or discounted to a sale price in response to competitors’ prices or other economic conditions. Price, cost, and expenses of a product determine the profit for that product. Understanding the relationships between these variables is crucial in maintaining a successful business. In this chapter, we will learn how to calculate the cost of products if trade discounts are offered within the supply chain, as well as how to calculate the amount of cash to be paid when cash discounts are offered for early payment. We will also learn how to calculate price and profit when the cost is marked up, as well as the discounted price and resulting profit or loss when a product is offered “on sale.” Computing discount amounts: The supply chain is made up of manufacturers, distributors, wholesalers, and retailers. Merchandise is usually bought and sold among the members of the chain on credit terms. The prices quoted to other members often involve trade discounts. A trade discount is a reduction of a list price or manufacturer’s suggested retail price (MSRP) and is usually stated as a percent of the list price or MSRP. 49 | P a g e Trade discounts are used by manufacturers, distributors, and wholesalers as pricing tools for several reasons, such as to (a) Determine different prices for different levels of the supply chain; (b) Communicate changes in prices. (c) Enable changes in prices. When computing a trade discount, keep in mind that the rate of discount is based on the list price. When the amount of the discount and the discount rate are known, the list price can be determined. Rearrange Formula 6.1 to determine the list price. Since the rate of trade discount is based on the list price, computing a rate of discount involves comparing the amount of discount to the list price. Rearrange Formula 6.1 to determine the rate of trade discount. 50 | P a g e The net price is the remainder when the amount of discount is subtracted from the list price. The net price is the price to the supplier, and becomes the cost to the purchaser. To compute the amount of the discount and the net price when the list price and discount rate are known, first apply Formula 6.1 to determine the amount of the trade discount, and then apply Formula 6.2 to calculate the net price. 51 | P a g e 52 | P a g e 1. An item with a list price of $125.64 is offered at a discount of 37.5%. What is the net price? 2. An item with a list price of $49.98 is offered at a discount of 1623 %. What is the net price? 3. A 17.5% discount on a flat-screen TV amounts to $560. What is the list price? 4. Golf World sells a set of golf clubs for $762.50 below the suggested retail price. Golf World claims that this represents a 62.5% discount. What is the suggested retail price (or list price)? 5. A 1623 % discount allowed on a flash drive amounted to $14.82. What was the net price? 6. A store advertises a discount of $44.75 on a pair of running shoes. If the discount is 25%, for how much were the running shoes sold? 7. The net price of a pair of hockey skates after a discount of 1623 % is $355. What is the list price? 8. The net price of an article is $63.31. What is the suggested retail price (the list price) if a discount of 35% was allowed? 9. A mountain bike listed for $975 is sold for $820. What rate of discount was allowed? 10. A home theatre system listed at $1136 has a net price of $760. What is the rate of discount? 53 | P a g e