Kotler 2020, Chapter 11 - Pricing Strategies PDF

CHAPTER 11 – Pricing strategies Mini contents ◦ Company case - It's complicated: price-setting in the medical technology industry ◦ What is a price, actually? ○ Factors to consider when setting prices ◦ Real Marketing -LEGO: successfully reviving the positioning strategy and value proposition. Real Marketing -I Apple: premium priced and worth it ◦ New-product pricing strategies ◦ Product mix pricing strategies ◦ Price-adjustment strategies. Real Marketing - Dynamic pricing at easyJet and Ryanair. Price changes MSC Cruises: from one second-hand ship to a. Company case major world player Chapter preview In this chapter we look at a second major marketing mix tool - pricing. If effective product development, promotion and distrib ution sow the seeds of business success, efféective pricing is the harvest. Having said this, the overall pricing strategy reflects the company, its brand and its product attractiveness, thus being an outcome of rather than input to the company's business model. Firms successf ul at creating customer value with the other marketing mix activities must still capture some of this value in the prices they earn. Yet, despite its importance, many firms do not handle pricing well. In this chapter we'll look at internal and external considerations that affect pricing decisions and examine both general pricing approaches and applied pricing strategies: new-product pricing strategies, product mix pricing strategies, price adjustment strategies and price reaction strategies. We start the chapter with a story about Medtronic, the world's largest medical technology company, operating in an industry that is - like many others- characterized by intensive competition, high development costs, long product life cycles. high margins and an interesting mixture of business and consumer market characteristics The company must also consider what impact its prices will have on other parties in its business environment. Learning objectives After reading this chapter, you should be able to: 1. D iscuss the importance of understanding customer value perceptions when setting prices. 2. Discuss the importance of company and product costs in setting prices. Identify and define the other important external and internal factors affecting a firm's pricing decisions. Describe the major strategies for pricing imitative and new products. 5. Discuss how companies adjust their prices to take into account different types of customers and situations. 6. Discuss the key issues related to initiating and responding to price changes ______________________________________________________________________________________________________________ Value-seeking customers have put increased pricing pressure on many companies. Thanks to global players in different industries - H&M, IKEA, Ryanair, Uber and Walmart - consumers enjoy the opportunities of buying cheaper products and many companies are looking for ways to slash prices. In many industries, goods have become a lot cheaper. However, cutting prices is often not the best answer. Reducing prices unnecessarily can lead to lost profits and damaging price wars. It can signal to customers that the price is more important than the customer value a brand delivers. Instead, companies should sell value, not just a low price. They should persuade customers that paying a higher price for the company's brand is justi fied by the greater value they gain. The challenge is to find the price that will let the company make a fair proft by getting paid for the customer value it creates Pricing decisions are subject to a complex array of company, environmental and competi- tive forces. To make things even more complex, a company sets not a single price but rather a pricing structure that covers different items in its line. This pricing structure changes over time as products move through their life cycles, and as the competitive environment and cost structures change,the company considers when to initiate price changes and when to respond to them. What is a price, actually? Price – The amount of money charged for a product or service, or the sum of the values that customers exchange for the benefits of having or using the product or service. In the narrowest sense, price is the amount of money charged for a product or service. From a broader marketing perspective, price is the sum of all the values that customers give up in order to gain the benefits of having of using a product or service, Historically, price has been the major factor affecting buyer choice, In recent decades, non-price factors have gained increasing importance but price still remains one of the most important elements determining a firm's market share and profitability. Price is the only element in the marketing mix that produces revenue, all other elements represent costs. Price is also one of the most flexible marketing mix elements. Unlike product features and channel commitments, prices can be changed quickly. At the same time, pricing is the number-one problem facing many marketing executives, and many companies do not handle pricing well. One frequent problem is that companies are too quick to reduce prices in order to get a sale rather than convincing buyers that their product's greater value is worth a higher price. While the company overall is putting a great deal of effort into increasing customer value, strengthening the brand and increasing price premium over competitors, prices may be reduced too much and too quickly to get more short-term sales. It is important to be aware of this tension between pricing and sales figures, on the one hand, and other activities that attempt to improve customer value and thus the opportunities to charge a higher price, on the other. Thus, pricing may be too cost-oriented rather than customer value oriented. It is not uncommon to hear managers complain that the company's products are given away for too low a price. Some managers view pricing as a big headache, preferring instead to focus on the other marketing mix elements. However, smart managers treat pricing as a key stra- tegic tool for creating and capturing customer value. Prices have a direct impact on a firm's bottom line. A small percentage improvement in price can generate a large percentage in prof- itability. More importantly, as a part of a company's overall value proposition, price plays a key role in creating customer value and building customer relationships. Instead of running away from pricing,' says the expert, 'savvy marketers are embracing it". Factors to consider when setting prices In setting the right price, a host of factors come into play. The price the company charges will fall somewhere between one that is too high to produce any demand and one that is too low to produce a profit. Figure 11.1 summarizes the major considerations in setting price. Customer perceptions of the product's value set the ceiling for prices. If customers perceive that the price is greater than the product's value, they will not buy the product. Product costs set the floor for prices In setting its price between these two extremes, a company must consider a number of other internal and external factors, including its overall marketing strategy and mix, the nature of the market and demand, and competitors' strategies and prices. Customer perceptions of value In the end, the customer Will decide whether a product's price iS right. When customers buy a product, they exchange something of value (the price) in order to get something of value (the benefits of having or using the product). Effective, customer-oriented pricing involves under. standing how much value consumers place on the benefits they receive from the product and setting a price that captures this value Value-based pricing Value-based pricing – Setting price based on buyers' perceptions ofvalue rather than on the seller's cost. Good pricing begins with a complete understanding of the value that a product or service creates for customers. Value-based pricing uses buyers' perceptions of value, not the seller's cOst, as the key to pricing. Hence, the marketer cannot design a product and marketing programme and then set the price. Price iS considered along with the other marketing mix variables before the marketing programme is set. Figure 1.2 compares value-based pricing with cost-based pricing. Cost-based pricing is product-driven, and input to prices comes from calculations and controlling. The company designs what it considers to be a good product, adds up the costs of making the product, and sets a price that covers coStS plus target profit. Marketing must then convince buyers that the product's value at that price justifies its purchase. If the price turns out to be too high, the company must settle for lower mark-ups or lower sales, both resulting in disappointing profits. Value-based pricing reverses this process. The company first assesses customer needs and value perceptions. It then sets its target price based on customer perceptions of value. The targeted value and price then drive decisions about what costs can be incurred and the resulting product design. As a result, pricing begins with analysing consumer needs and value perceptions. Input comes from the market, not from the controlling Department. The customer's value perception must not exceed the company's costs of producing a particular product. In many cases, customers are not willing to pay the price of a product, and companies stop producing and selling it or decide not to start manufacturing it at all after getting this information from marketing research. Some activities may be outsourced, thus allowing the company to offer the product at a price the customer will accept. It is some- times cheaper to source activities from another company than to produce them in-house. For example, parcel delivery will be cheaper to buy from companies specialized in parcel delivery than letting the company run it. It's important to remember that good value' is not the same as 'low price`, For example, some car buyers consider the luxurious Bentley Continental GT car to be really good value, even at an eye-popping price of SEK 1,950,000. Around 10,000 new Bentleys are sold every year, indi- cating that at least these buyers find the car delivers good value certainly like many others who can't afford it: Every Bentley GT is built by hand, and craftsmen spend 18 hours simply stitching the perfectly joined leather of the Gr's steering wheel, almost as long as it takes to assemble an entire Volkswagen Golf. The results are impressive: Dash and doors are mirrored with walnut veneer, pedals are carved from aluminium, window and seat toggles are cut from actual metal rather than plastic, and every air vent is perfectly chromed within a car that has brilliantly incorporated technological sophistication. With this perspective, the GT could be seen as a bargain. A company using value-based pricing must find out what value buyers assign to different competitive offers. However, companies often find it hard to measure the value customers will attach to its product. For example, calculating the cost of ingredients in a meal at a fancy restaurant is relatively easy. But assigning a value to other satisfactions such as taste, envi- ronment, relaxation, conversation and status is very hard. And these values will vary both for different consumers and different situations. Still, consumers will use these perceived values to evaluate a product's price, so the company must work to measure them. Sometimes, companies ask consumers how much they would pay for a basic product and for each benefit added to the offer. Or a company might conduct experiments to test the perceived value of different product offers. The rule is easy. If the seller charges more than the buyers' perceived value, the company's sales will suffer. If the seller charges less, its products sell very well. But they produce less revenue than they would if they were priced at the level of perceived value. We now examine two types of value-based pricing: good-value pricing and value-added pricing. Good-value pricing Good-value pricing – Offering just the right combination of quality and good service at a fair price. During the past decade, marketers have noted a fundamental shift in consumer attitudes towards price and quality. More and more, marketers have adopted good-value pricing strategies -offering just the right combination of quality and good service at a fair price. Examples include the introduction of less expensive versions of established, brand name products, e.g. cheaper lines of premium clothing brands, restaurants offering 'value menus' or hotels offering family packages. As a response to companies' decisions to implement tougher policies on travel costs in general and flying business class in particular, airlines have introduced Premium Economy classes named Plus (SAS), Premium Voyageur (Air France/KLM) 1O World Traveller Plus (British Airways). With this approach, the traveller is offered what frequent business travellers need at a cost of about half the business class ticket. An important type of good-value pricing at the retail level is everyday low pricing (DLP). EDLP involves charging a constant, everyday low price with few or no temporary price discounts, e.g. nappies, or 10 litres of milk in 2 city centre ICA Supermarket to attract local customers who may be attracted by the even lower prices at ICA Maxi. An upmarket restaurant may offer lunch menus or value menus that make the restaurant available to more people – and make them spread the word about the restaurant and come back for a full price dinner at a later occasion. Value-added pricing Value-based pricing doesn't mean simply charging what customers want to pay or setting low prices to meet the competition. In many marketing situations, the challenge is to build the company's pricing power its power to escape price competition and to justify higher prices and margin. To increase pricing power, a firm must retain or build the value of its market offering. This is especially true for suppliers of commodity products, which are characterized by little differentiation and intense price competition. Value-added pricing – Attaching value-added features and services to differentiate a company's offers and thus support higher prices. To increase their pricing power, many companies adopt value-added pricing strategies. Rather than cutting prices to match competitors, they attach value-added features and services to differentiate their offers and thus support higher prices. Customers are motivated not by price, but by what they get for what they paid. If consumers thought the best deal was simply a question of money saved, we'd all be shopping in one big discount store,' says one pricing expert. 'Customers want value and are willing to pay for i Savvy marketers price their products accordingly.' This book provides many examples - in all chapters - of companies applying value-added pricing. Offering something different and getting paid for it is an essential marketing strategy. Company and product costs Cost-based pricing – Setting prices based on the costs of producing, distributing and selling the product plus a fair rate of return for effort and risk. Costs set the floor for the price but the goal isn't always to minimize costs. In fact, many firms invest in higher costs so that they can claim higher prices and margins (think about Bentley cars discussed above). The key is to manage the spread between costs and prices-how much the company makes for the customer value it delivers. Whereas customer-value perceptions set the price ceiling, costs set the floor for the price that the company can charge. Cost-based pricing involves setting prices based on the costs for producing, distributing and selling the product plus a fair rate of return for its effort and risk. A company's costs may be an important element in its pricing strategy. Some companies, such as Ryanair, Walmart and Dacia, work to become the 'low-cost producers' in their industries. Companies with lower costs can set lower prices that result in smaller margins but greater sales and profits. Other companies, however, intentionally pay higher costs so that they can claim higher prices and margins. It costs more to make a Dynaudio sound system than a Philips sound system but the higher costs result in higher quality, and more customer value. Cost structures The company must watch its costs carefully. If it costs the company more than competitors to produce and sell its product, the company will need to charge a higher price or make less profit, putting it at competitive disadvantage. Costs at different levels of production To price wisely, management needs to know how its coStS vary with different levels of produc tion. For example, suppose Samsung has built a plant to produce 1,000 mobile phones per day. Figure 11.3(a) shows the typical short-run average cost curve (SRAC). It shows that the cost per phone is high if Samsung's factory produces only a few per day. But as production moves up to 1,000 phones per day, average cost falls as fixed costs are spread over more units. Samsung tries to produce more than 1,000 mobile phones per day, but average costs will increase because the plant becomes inefficient. Workers have to wait for machines, the machines break down more often, and workers get in each other's way. If Samsung believed it could sell 2,000 mobile phones a day, it should consider building a larger plant. The plant would use more efficient machinery and work arrangements. Also, the unit cost of producing 2,00o units per day would be lower than the unit cost of producing 1,000 units per day, as shown in the long-run average COst (LRAC) curve (Figure 11.3(b). In fact, a 3,000-capacity plant would even be more efficient, according to Figure 11.3(b). But a 4,000-daily production plant would be less efficient because of increasing diseconomies of scale-too many workers to manage, paperwork slowing things down, and so on. Figure 11.3(b) shows that a 3,000 daily production plant is the best size to build if demand is strong enough to support this level of production. Costs as a function of production experience Suppose Samsung runs a plant that produces 3,000 units per day. As Samsung gains experi ence in producing phones, it learns how tO do I better. Workers learn shortcuts and become more familiar with their equipment. With practice, the work becomes better organized, and better equipment and production processes develop. With higher volume, Samsung becomes more eficient and gains economies of scale. As a result, average cost tends to fall with accumulated production experience. This is shown in Figure 11.4. Thus, the average cost of producing the first 100,000 mobile phones is sEK 200 per unit. When the company has produced the first 200,000 mobile phones the average cost has fallen to Sek 180. After its accumulated production experience doubles again to 400,000, the average cost is SEK 140. This drop in the average cost with accumulated production experience is called the experience curve, or the learning curve. Experience curve (learning curve) – The drop in the average per-unit production cost that comes with accumulated production experience. If a downward- sloping experience curve exists, this is highly significant for the company. Not only will the company's unit production cost fall, but it will all faster if the company makes and sells more during a given time period. But the market has to be ready to buy the higher output. And to take advantage of the experience curve, Samsung must get a large market share early in the product's life cycle. This suggests the following pricing strategy: Samsung should price its mobile phones low; its sales will then increase, and its costs will decrease through gaining more experience, and then it can lower its prices further. Changing consumer demands and increased flexibility in manufacturing have reduced the power of the experience curve. First, unlike examples still used in some literature n calculus, it is not as expensive as it was in the past to provide different product versions and lines in the same factory. Secondly, and probably more importantly, consumers now represent a broader range of preferences. Economies of scale may also be interpreted from a broader perspective. Ryanair is certainly not the biggest airline in the world. It lies to 239 airports while Delta Airlines flies to 304. Delta operates more than 80o aircraft, almost twice as much as Ryanair with 475 aircraft and 210 on order. But Ryanair makes use of economies of scale thinking: they only operate one aircraft – the Boeing 737 – on all routes. Most airlines of Ryanair's size have five to 15 different types of aircraft in use, which means considerable complexity in planning, procurement, spare parts stock-keeping, pilot training etc, Ryanair saves a lot by applying the one-aircraft- fits-all approach. Needless to say, they lose some flexibility on the other hand but with the ambition to be the operator in the industry with the lowest costs, the economies of scale approach makes sense. A single-minded focus on reducing costs and exploiting the experience curve will not always work. Experience-curve pricing carries some major risks. The aggressive pricing might give the product a cheap image. The strategy also assumes that competitors are weak and not willing to fight it out by meeting the company's price cuts. Finally, while the company is building volume under one technology, a competitor may find a lower-cost technology that lets it start at prices lower than those of the market leader, who still operates on the old experience curve. Cost-plus pricing Cost-plus pricing – Adding a standard mark-up to the cost of the product. The simplest pricing method is cost-plus pricing - adding a standard mark-up to the cost of the product. Construction companies, for example, submit iob bids by estimating the total project cost and adding a standard mark- up for profit. Lawyers, accountants and other professionals typically price by adding a standard mark-up to their costs. Some sellers tell their customers they will charge cost plus a specified mark-up; for example, aerospace companies price this way to the government. To illustrate mark-up pricing, suppose a toaster manufacturer had the following costs and expected sales: Variable cost: SEK 100 Fixed cost: SEK 3,000,000 Expected unit sales: 50,000 The manufacturer would charge dealers SEK 200 per toaster and make a profit of SEK 40 per unit. The dealers, in turn, will mark up the toaster. If dealers want to earn 50 per cent on the sales price, they will mark up the toaster to SEK 400 (SEK 200+ 50% of SEK 400). This number is equivalent to a mark-up on cost of 100 per cent (SEK 200/sEk 200). Does using standard mark-ups to set prices make sense? Generally, no. Any pricing method that ignores demand and competitor prices is not likely to lead to the best price. Still, mark-up pricing remains popular for many reasons First,sellers are more certain about costs than about demand. By tying the price to cost, sellers simplify pricing - they do not need to make frequent adjustments as demand changes. Secondly, when all firms in the industry use this pricing method, prices tend to be similar and price competition is thus minimized. Thirdly, many people feel that cost-plus pricing fairer to both buyers and sellers. Sellers earn a fair return on their investment but do not take advantage of buyers when buyers' demand becomes great. Break-even analysis and target profit pricing Break-even pricing (target profit pricing) – Seting priceto break even on the costs of making and marketing a product or setting price to make a target profit. Another cost-oriented pricing approach is break-even pricing (or a variation called target profit pricing). The firm tries to determine the price at which it will break even or make the target profit it is seeking. Such pricing is used by car manufacturers, who price their cars to achieve a 15-20 per cent profit on their investment. This pricing method is also used by public utilities, which are constrained to make a fair return on their investment. Target pricing uses the concept of a break-even chart, which shows the total cOst and total revenue expected at different sales volume levels Figure 11.5 shows a break-even chart for the toaster manufacturer discussed here. Fixed COsts are SEK 3,000, 000 regardless of sales volume. Variable costs are added to fixed COSts to form total COsts, which rise with volume. The total revenue curve starts at zero and rises with each unit : sold. The slope of the total revenue curve reflects the price of SEK 200 per unit. The total revenue and total cost curves cross at 30,000 units. This is the break-even volume. At SEk 200, the company must sell at least 30,000 units to break even, that is, for total revenue to cover total cost. Break-even volume can be calculated using the following formula: Break – even volume = (fixed cost) / (price–variable cost). Example: SEK 30 000 000 / SEK 200 – 100 = 30 000. If the company wants to make 2 target profit, it must sell more than 30,000 units at SEK 200 each. Suppose the toaster manufacturer has invested SEK 10,000,000 in the business and wants to set price to earn a 20 per cent return, or SEK 2,000,000. In that case, it must sell at least 50,000 units at SEK 200 each. If the company charges a higher price, the market may not buy even a lower needed volume. Much depends on the price elasticity and competitors' prices. The manufacturer should consider different prices and estimate break-even volumes, probable demand and profits for each. This is done in Table 11.1. The table shows that as price increases, break-even volume drops (column 2). But as price increases, demand for the toasters also falls off (column 3). At the SEK 140 price, because the manufacturer clears only SEK 40 per toaster (SEK 14 SEK 10 in variable cOsts), it must sell a very high volume to break even. Even though the low price attracts many buyers, demand still falls below the high break-even point, and the manufacturer loses money. At the other extreme with a SEK 220 price the manufacturer clears SEK 120 per toaster and must sell only 25,000 units to break even. But at this high price, consumers buy too few toasters, and profits are negative. The table shows that a price of SEK 180 yields the highest profits. Note that none of the prices produce the manufacturer's target profit of SEk 2,000. 000. To achieve this target return, the manufacturer will have to search for ways to lower fixed or variable costs thus lowering the break-even volume. Customer perceptions of value set the upper limit for prices and costs set the lower limit. However, in setting prices within these limits, the company must consider a number of other internal and external factors. Other internal and external considerations affecting price decisions Now that we've looked at the three general pricing strategies value-, cost-, and competitor- based pricing -let's dig into some of the many other factors that affect pricing decisions. Beyond customer value perceptions, costs, and competitor strategies, the company must consider several additional internal and external factors. Internal factors affecting pricing include the company' 'S overal] marketing strategy, objectives, and marketing mix as well as other organizational considerations. External factors include the nature of the market and demand and other environmental factors. Overall marketing strategy, objectives and mix If the company has selected its target market and positioning carefully, then its pricing strategy will be fairly straightforward. Pricing may play an important role in helping to accomplish company objectives at many levels. A firm can set prices to attract new customers or to profitably retain existing ones. It can set prices low to prevent competition from entering the market or set prices at competitors' levels to stabilize the market. It can price to keep the loyalty and support of resellers or to avoid government intervention. Prices can be reduced temporarily to create excitement for a brand. Or one product maybe priced to help the sales of other products in the company's line. Price is only one of the marketing mix tools that a company uses to achieve its marketing objectives. Price decisions must be coordinated with other product mix decisions to form a consistent and effective integrated marketing programme. A decision to position the product on high-performance quality will mean that the seller must charge a higher price to cover higher costs. And producers whose marketing channels are expected to support and promote their products may have to build larger reseller margins into their prices. Premium brand retailers, in particular, need higher margins, since volumes are normally lower while oper- ating costs are higher. Bang & Olufsen expect their retailers to provide an impressive show- room with lots of space to look at their products. Moreover, by exposing the entire product range, the chance of a customer buying a more expensive product is higher than if the upper-range products are only shown in brochures and on the producer website. Thus, Bang & Olufsen want their retailers to exhibit the entire product range. Companies often position their products on price and then tailor other marketing mix deci- sions to the prices they want to charge, Here, price is a crucial product-positioning factor that defines the product's market, competition and design. Many firms support such price-posi- tioning strategies with a technique called target costing, a potent strategic weapon. Target costing reverses the usual process of first designing a new product, determining its cost, and then asking, 'Can we sell it for that? Instead, it starts with an ideal selling price based on customer-value considerations and then targets costs that will ensure that the price is met For example, when budget providers of food decide to introduce a new product, they first make sure that a target price of say seK 12.90 or 14.90 can be reached. Target costing – Pricing that starts with an ideal selling price, then targets costs that will ensure that the price is met. Organizational considerations Management must decide who within the organization should set prices. Companies handle pricing in a variety of ways. In small companies, prices are often set by top management rather than by the marketing or sales departments. In large companies, pricing is typically handled by divisional or product managers. In industrial markets, salespeople may be allowed to negotiate with customers within certain price ranges. Even SO, top management sets the pricing objectives and policies, and it often approves the prices proposed by lower- level management or salespeople. In industries in which pricing is a key factor (airlines, steel, railroads, oil companies), compa- nies often have pricing departments to set the best prices or help others set them. These departments report to the marketing department or top management. Others who have an influence on pricing include sales managers, production managers, finance managers, and accountants. The market and demand: pricing in different types of markets In this section, we take a deeper look at the price-demand relationship and how it varies for different types of markets. We then discuss methods for analysing the price-demand relation: ship. The seller's pricing freedom varies with different types of markets. Economists recognize four types of markets, each presenting a different pricing challenge. Under pure competition, the market consists of many buyers and sellers trading in a uniform commodity such as wheat, copper or financial securities. No single buyer or seller has much effect on the going market price, If price and profits rise, new sellers can easily enter the market. In a purely competitive market, marketing research, product development, pricing, advertising and sales promotion play little or no role. Thus, sellers in these markets do not spend much time on marketings strategy. Under monopolistic competition, the market consists of many buyers and sellers who trade over a range of prices rather than a single market price, A range of prices occurs because sellers can differentiate their offers to buyers. Either the physical product can be varied in quality, features Or style, Or the accompanying services can be varied. Buyers see differences in sellers' products and will pay different prices for them. Sellers try to develop differentiated offers for different customer segments and, in addition to price, freely use branding, adver- tising and personal selling to set their offers apart. Under oligopolistic competition, the market consists of a few sellers who are highly sensitive to each other's pricing and marketing strategies. The product can be uniform (steel, aluminium) or non uniform (cars, computers). There are few sellers because it is difficult for new sellers to enter the market. Each seller is alert to competitors' strategies and moves. If OKQ8 were to slash its fuel price by 10 per cent, buyers would quickly switch to this supplier. The other petrol stations would have to respond by lowering their prices or increasing their services. In a pure monopoly the market consists of one seller. The seller maybe government monopoly - which are far less common today in the aftermath of extensive deregulation, in the case of Sweden pharmacies, car inspections etc., there are private regulated monopo- lies (a power company), and private non-1 regulated monopolies (Nespresso coffee machine capsules or vacuum cleaner bags). Pricing is handled differently in each case. In a regulated monopoly, the government permits the company to set rates that will yield a fair return'. Non-regulated monopolies are free to price at what the market will bear. However, they do not always charge the full price for a number of reasons: a desire not to attract competition, a desire to penetrate the market faster with a low price, or a fear of government regulation. Demand curve – A curve that shows the number of units the market will buy in a given time period, at different the prices that might be charged. Analysing the price-demand relationship Each price the company might charge will lead to a different level of demand. The relation- ship between the price charged and the resulting demand level is shown in the demand curve in Figure 11.6. The demand curve shows the number of units the market will buy in a given time period at the different prices that might be charged In the normal case, demand and price are inversely related; that is, the higher the price, the lower the demand. In the case of prestige goods, the demand curve sometimes slopes upward. Consumers think that higher prices mean more quality. For example, Gibson Guitar Corporation once toyed with the idea of lowering its prices to compete more effectively with rivals such as Yamaha and Ibanez that make cheaper guitars. To its surprise, Gibson found that its instruments didn't sell as well at lower prices. 'We had an inverse [price-demand relationship],' noted Gibson's chief executive. 'The more we charged, the more product we sold. At a time when other guitar manufacturers have chosen to build their instruments more quickly, cheaply and in greater numbers. Gibson still promises guitars that 'are made one- at-a-time, by hand. No shortcuts. No substitutions.' Most companies try to measure their demand curves by estimating demand at different prices. The type of market makes a difference. In a monopoly, the demand curve shows the total market demand resulting from different prices. If t the company faces competition, its demand at different prices will depend on whether competitors' prices stay constant or change with the company's own prices. Price elasticity of demand Price elasticity – A measure of the sensitivity of demand to changes in price. Marketers also need to know price elasticity - how responsive demand will be to a change in price. Consider the two demand curves in Figure 11.6. In Figure 11.6(a), a price increase from Px to P2 leads to a relatively small drop in demand from Ch to Q2. In Figure 11.6(b), however, the same price increase leads to a large drop in demand from Q1 to Q2. If demand hardly changes with a small change in price, we say the demand is inelastic. If demand changes greatly, we say the demand is elastic. The price elasticity of demand is given by the following formula: Price elasticity of demand =(% change in quanity demanded)/ (% Change in price) Suppose demand falls by 10 per cent when a seller raises its price by 2 per cent. Price elasticity of demand is therefore 5 (the minus sign confirms the inverse relation between price and demand) and demand is elastic. If demand falls by per cent with a 2 per cent increase in price, then elasticity is -1. In this case, the seller's total revenue stays the same: the seller sells fewer items but at a higher price that preserves the same total revenue. If demand falls by 1 per cent when price is increased by2 per cent, then elasticity is -1/2 and demand is inelastic. The less elastic the demand, the more it pays for the seller to raise the price. What determines the price elasticity of demand? Buyers are less price-sensitive when the product they are buying is unique or when it is high in quality, prestige or exclusiveness. They are also less price-sensitive when substitute products are hard to find or when they cannot potatoes in mid- summer, consumers are less price-sensitive. Finally, buyers are less price- sensitive when the total expenditure for a product is low relative to their income or when the cost is shared with another party.8 A convenience store may charge twice the supermarket retail price for frozen dill pickles or baking powder, but hardly anything more for milk, typical day to day product about which consumers are well informed and therefore rather price-sensitive. If demand is elastic rather than inelastic, sellers will consider lowering their prices. A lower price will produce more total revenue,. This practice makes sense as long as the extra costs of producing and selling more do not exceed the extra revenue. At the sare time, most firms want to avoid pricing that turns their products into commodities. In recent years, forces such as deregulation, dips in the economy and the instant price comparisons afforded by the Internet and other technologies have increased consumer price sensitivity. The economy Economic conditions can have a strong impact on the firm's pricing strategies. Economic factors such as a boom or recession, inflation, and interest rates affect pricing decisions because they affect consumer spending, consumer perceptions of the product's price and value, and the company's costs of producing and selling a product. In the aftermath of the Great Recessions of 2008 and 2020 respectively, many consumers rethought the price-value equation. They tightened their belts and become more value conscious. Consumers have continued their thriftier ways well beyond the economic recovery. As a result, many marketers have increased their emphasis on value-for-the-money pricing strategies. The most obvious response to the new economic r realities iS to Cut prices and offer discounts. Thousands of companies have done just that. Lower prices make products more affordable and help spur short-term sales. However, such price cuts can have undesirable long- term consequences. Lower prices mean lower margins. Deep discounts may cheapen a brand in consumers' eyes. And once a company cuts prices. it's difficult t to raise them again when the economy recovers. Remember, even in tough economic times, consumers do not buy based on prices alone. They balance the price they pay against the value they receive. Thus, no matter what price they charge - low or high - companies need to offer great value for the money. Competitors' strategies and prices In setting its prices, the company must also consider competitors' costS, prices and market offerings. Consumers will base their judgments of a product's value on the prices that competitors charge for similar products. A consumer who is thinking about buying a Gotrax e- scooter will evaluate Gotrax's customer value and price against the value and prices of comparable products. In addition, the company's pricing strategy may affect the nature of the competition it faces. If Gotrax follows a high-price, high-margin strategy, it may attract competition. A low-price, low-r margin strategy, however, may stop competitors or drive them out of the market. In assessing competitors' pricing strategies, the company should ask several questions. First, how does the company's market offering compare with competitors' offerings in terms of customer value? If consumers perceive that the company's product or service provides greater value, the company can charge a higher price. Next, how strong are current competitors and what are their current pricing strategies? If the company faces a host of smaller competitors charging high prices relative to the value they deliver, it might charge lower prices to drive weaker competitors out of the market. If the market is dominated by larger, low- price competitors, the company may decide to target unserved market niches with value added products at higher prices. Finally, the company should ask: how does the competitive landscape influence customer price sensitivity? Customers will be more price-sensitive if they see feW differences between competing products and buy whichever product cOsts the least. The more information customers have about competing products and prices before buying, the more price-sensitive they will be. Easy product comparisons help customers to assess the value of different options and to decide what prices they are willing to pay. Finally, customers will be more price-sensitive if they can switch easily from one product alternative to another. Other external factors Beyond the market and the economy, the company must consider several other factors in its external environment when setting prices. It must know what impact its prices will have on other parties in its environment. How will marketing channels react to various prices? The company should set prices that give marketing channel members a fair profit, encourage their support, and help them to sell the product effectively. The, governmenti is another important external influence on pricing decisions. Finally, social concerns may need to be taken into account In setting prices, a company's short-term sales, market share, and profit goals may need to be tempered by broader societal considerations. New-product pricing strategies Pricing new products can be especially challenging. Just think about all the things you'd have to consider in pricing a new product, say the first portable microwave oven or the iWatch Apple Watch. What's more, you'd have to start thinking about the price along with many other marketing considerations at the very beginning of the design process. Marketing research may not provide sufficient information and it's difficult to know what will happen in the marketplace before the product is being launched, For instance, marketing research may indi- cate that consumers have a high interest in and are willing to pay a significant price premium for a sustainable product - but when the product reaches the marketplace, it has other flaws that make it unattractive in relation tO competitors' products, hence, the company can't charge the prices it planned. Or the other way round: consumers indicate in marketing research that they would go for an option of cheap inter-continental flights based on a no-frills, budget offer, but when the product is launched, consumers realize that the environmental impact of air travel – particularly in the budget airline's old aircraft – as well as lack of social sustainability: co-workers are not working under fair conditions hence, demand is lower than expected and reducing prices doesn't help. It would further underline the sustainability issues. 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 frst time, and the decisions made will have a long -term impact On how the new product will be perceived, priced and marketed in years to come. Companies can choose between two broad strategies: market-skimming pricing and market-penetration pricing. Market-skimming pricing Market-skimming pricing – 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. Home electronics companies, e.g. Sony and Samsung, frequently use this strategy, called market-skimming pricing (or price skimming). New products are introduced at high prices and purchased only by customers who really want the new tech- nology and can afford to pay a high price for it. The prices then come down both through Sony' S and Samsung's S ambitions to skim the maximum amount of revenue from each segment of the market, and as new competitors enter 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, Secondly, the costs of producing a smaller volume cannot be SO high that they cancel out the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price. This approach is used particularly when a product is new on the market. Market-penetration pricing Market-penetration pricing – Setting a low price for a new product in order 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. They set a low initial price in order to penetrate the market quickly and deeply to attract large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing the companies to cut their prices even further. For example, Dell used penetration pricing to enter the personal computer market, selling high-quality computer products through lower-cost direct channels. Its sales soared when HP, Apple and other competitors selling through retail stores could not match its prices. And IKEA uses penetration pricing to boost its success in many markets. The same holds for Ryanair and many other budget brands: it is almost impossible for companies with lower sales volume to compete on price. 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. Secondly, production and distribution costs must fall as sales volume increases. Finally, the low price must help to keep out the competition, and the penetration pricer must maintain its low- price position otherwise, the price advantage maybe only temporary. Product mix pricing strategies Most individual products are part of a broader product mix and must be priced accord- ingly. The strategy for setting a product's price often has to be changed when the product is part of a product mix, as is normally the case. Firms look for a set of prices that maxi- mizes the 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 11.2: product line pricing, optional-product pricing, captive-product pricing, by-product pricing and product bundle pricing. Product line pricing 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. With product line pricing, price steps are between various products in a product line based on cost differences between the products, customer evaluations of different features and competitors' prices. The price steps should take into account cost differences between the products in the line, and in line with a modern approach where customers' willingness to pay is crucial - they should account for differences in customer perceptions of the value of different features. This approach is very common and is used throug hout the industry of, e.g., white goods, home electronics, bicycles, cars and boats. It is also highly applicable to services, e.g. haircut at premium hair salon Björn Axến in Stockholm: trainee haircut SEK 400; junior hairdresser stylist haircut SEK 1,300. The *creative director would charge you SEK 2,300, Coop's online haircut SEK 600; hairdresser haircut SEK 860; top stylist haircut SEK 1,100; and senior top store charges SEK 19 to 149 for delivery to consumers, VAT included - companies will have to pay SEK 140 + VAT, which is SEK 180. Optional-product pricing 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 prod- ucts along with their main product. For example, a car rental company offers booster seats for toddlers at a cost of about EUR 15 a day very expensive compared with the cost of buying one for EUR 20 to 30. From the customer perspective, however, paying an additional fee is a very convenient way of getting the booster seat, particularly if visiting another country. Few parents would come up with the idea upon late arrival with toddlers in another country to drive to a supermarket that iS open late and buy a booster seat. Safety and con venience speak for taking the rental car company's offer. Pricing these options is a sticky problem, but a profitable one. In many cases, companies make all profits from additional services provided. Captive-product pricing Captive-product pricing – Setting a price for products that must be used along with a main product, such as blades fora razor and games for avideogame 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, computer games and printer cartridges. Producers of the main products razors, video game consoles, and printers) often price them low and set high mark-ups on the supplies. For example, Gillette sells low-priced razors but makes money On the replacement cartridges. Companies that use captive-product pricing must be careful – consumers trapped into buying expensive supplies may come to resent the brand that ensnared them. In the case of services, this captive-product pricing is called two-part pricing. The price of the service is broken into a fixed fee plus a variable usage rate. Mobile phone companies may charge a flat rate for a basic calling plan, then charge for minutes over what the plan allows, and connection fees have risen substantially in the last decade. Thus, a flat rate of SEk 499 per month may generate another seK 237.5 for the phone company if 250 calls at seK 0.95 connection fee are made. By-product pricing By-product pricing – Setting a price for by-products to help offset the costs of disposing of them and help make the main product's price more competitive. Producing products and services often generates by-products. If the by- products have no value and if getting rid of them is costly, this will affect the pricing of the main product. Using by-product pricing, the company seeks a market for these by-products to help ofiset the costs of disposing of them and to help make the price of the main product more competitive: The by-products themselves can even turn out to be profitable. For example, a slaughterhouse that once had to pay to dispose of its by products now gets paid for them by selling to compa- nies that produce biogas (see Chapter 1). Product bundle pricing Product bundle pricing – Combining several products and offering the bundle at a reduced price. Using product bundle pricing, sellers often combine several of their products and offer the bundle at a reduced price. For example, fast-l food restaurants bundle Q burger, salad and a soft drink at a 'combo' price. Resorts sell specially priced holiday packages that include airfare, accommodation, meals and entertainment. And charter airlines are doing the same. 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. Price-adjustment strategies Setting the base price for a product is only the start. The company must then adjust the price to adjust for customer and situational differences. Here we examine the seven price adjustment strategies summarized in Table 11.3: discount and allowance 1 pricing, segmented pricing, psychological pricing, promotional pricing, geographical pricing, dynamic pricing and international pricing. Discount and allowance pricing Most companies adjust their basic price to reward customers for certain responses, such as volume purchases and off- season buying. These price adjustments - called discounts and allowances- can take many forms. Discount– A straight reduction in price on purchases during a stated period of time. Discounts include quantity discounts, price reductions to buyers who buy large volumes. Such discounts provide an incentive to the customer to buy more from one given seller, rather than from many different sources. A functional discount (also called a trade discount) is offered by the seller 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. For example, lawn and garden equipment manufacturers offer seasonal discounts to retailers during the autumn and winter months to encourage early ordering in anticipation of the heavy spring and summer selling seasons, and winter tyres may be offered at a seasonal discount in the spring. Seasonal discounts allow the seller to keep production steady during an entire year. 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 allow- ances are price reductions given for turning in an old item when buying a new One. Promo- tional allowances are payments Or price reductions to reward dealers for participating in advertising and sales support programmes. Segmented pricing 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 – Selling a product or service at two or more prices, where 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, 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. A 0.5-litre bottle of Coke may cost SEK 12.90 at your local supermarket while a 1.5-litre bottle costs SEK 14.90. A dramatic difference in price per litre, but they are often bought for different purposes, the small one for portability and the big bottle for use at home. Using location pricing, a company charges different prices for different locations, even though the cost of offering each location is more or less the same. For instance, cinemas vary their seat prices because of audience preferences for certain locations. Finally, using time pricing, a firm varies its price by the season, the month, the day and even the hour. Some public utilities vary their prices to commercial users by time of day and weekend versus weekday. Resorts give weekend and seasonal discounts. Shell petrol stations used to offer 50 per cent off a car wash after 9pm meaning company car drivers will come besore 9pm as there willble less queuing, while those who have to pay the cost themselves are likely to come after 9pm, although that means queuing. Segmented pricing goes by many names. Airlines may call it revenue management OI yield management, to reflect the practice of selling the right product to the rig ht consumer at the right time for the right price. The airlines routinely set prices hour-by- -hour even minute- by- minute depending on seat availability, demand and competitor price changes. Thus, the price you pay for a given seat on a given flight might vary greatly depending not just on class of service, but also on when and where you buy the ticket. The person sitting next to you in an aircraft or fast train may have paid five times the amount you paid. For segmented pricing to be an effective strategy, the costs of segmenting and watching the market cannot exceed the extra revenue obtained from the price difference. Most importantly, segmented prices should reflect real differences in customers' perceived value. Consumers in higher price tiers must feel that they're getting their extra money's worth for the higher prices paid. Psychological pricing Psychological pricing – A pricing approach that considers the psychology of prices and not simply the economics; the price is used to say something about the product. Price says something about the product. For example, many consumers use price to judge quality. A sEK 800 bottle of perfume may contain only SEK 30 worth of scent, but some people are willing to pay the SEK 800 because this price indicates something special. In using psychological pricing, sellers consider the psychology of prices and not simply the economics. For example, consumers usually perceive higher- priced products as being of a 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 they lack the information OI skill. price becomes an important quality signal. Reference prices – Prices that buyers carry in their minds and refer to when looking 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 situa- tion. Sellers can influence or use these consumers? reference prices when setting price. For example a company could display its product next to more expensive ones in order to imply that it belongs in the same class. Department stores often sell women's clothing in separate departments diferentiated by price: clothing found in the more expensive department is assumed to be of better quality. Consumers don't have all the skill or information they need to determine whether they are paying a good price. They don't have the time, ability or incli- nation 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. 1 Imagine, for instance, that it's Saturday morning and you stop by your local supermarket to pick up a few items for a party. Walking through the aisles, you're bombarded with prices. But are they good prices? If you're like most shop- pers, you don't really know. So to help you out, retailers themselves give you a host of subtle and not-so-subtle signals telling you whether a given price is relatively high or low. For example, sales signs shout out Sale!", 'Reduced', Price after rebate!" or 'Now 2 for only..." Prices ending in 9 let you know that the product has to be a bargain. Another good clue is signpost pricing - low prices on products for which you have accurate price knowledge, suggesting that the store's other prices must be low as well. A price-matching guarantee also suggests that one store's prices are lower than another's - how else could they make such a promise? However, price-matching guarantees have been issued by companies offering odd low-cost products, which are not available from competitors - hence, the guarantee is practically useless Are such pricing signals really helpful hints? Research shows that the word sale beside a price (even without actually varying the price) can increase demand by more than 50 per cent. But do these signals really help customers? The answer, often, is yes careful buyers really can take advantage of such cues to find good buys. And if used properly, retailers can use such tactics to provide useful price information to their customers. Used improperly, however, they can mislead consumers, tarnishing brand and damaging customer relationships. Even small differences in price can signal product differences. Consider a bicycle at SEK 3,000 compared with one priced at SEK 2,995. The actual price difference is only SEK 5, but the psychological difference can be much greater. Some psychologists argue that each digit has symbolic and visual qualities that should be considered in pricing. Thus, 8 is round and even and creates a soothing effect, whereas 7 is angular and creates a jarring effect.12 Interestingly, digitization has contributed to more limited use of prices like SEK 1,999 or SEK 895- In online stores selling items that are available also through other distribution channels, price- setting is often based on margins formula that results in prices such as SEK 317 or SEK 5,127. Promotional pricing Promotional pricing – Temporarily pricing products below list price, and sometimes even below cost, to increase short-term 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, linens are promotionally priced every January to attract weary Christmas holiday shoppers back into 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. Some producers offer low-interest financing, longer warranties or free maintenance to reduce the consumer's 'price'. Promotional pricing, however, can have adverse effects. Used too frequently and copied by competitors, price promotions can create 'deal-1 prone customers who wait until brands goc on sale before buying them. Or constantly reduced prices can erode a brand's value in the eyes of customers. Marketers sometimes become addicted to promotional pricing, using price promo- tions as a quick fix instead of sweating through the dificult process of developing effective longer term strategies for building their brands. The use of promotional pricing can also lead to industry price wars. Geographical pricing 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 country or world. We will look at five geographical pricing strategies. FOB-origin pricing – Pricing in which goods are placed free on board a carrier; the customer pays the freight from the factory to the destination. One option is to charge each customer shipping and other costs. Called FOB-origin pricing. this practice means that the goods are placed free on board (hence, FOB) a carrier. At that point the title and responsibility pass to the customer, who pays the freight from the factory to the destination. The disadvantage is high costs for distant customers. Uniform-delivered pricing – Pricing in which the company charges the same price plus freight to all customers, regardless oftheir location. Uniform-delivered pricing is the opposite of FOB pricing. Here, the company charges the sameprice to all customers, regardless of their location. It is fairly easy to administer and facilitates marketing, since the seller can advertise its price nationally. Zone pricing – Pricing in which the company sets up two or more zones. All customers within a zone pay the same total price; the more distant the zone, the higher the price. Zone pricing falls between FOB-origin pricing and uniform-delivered pricing. The company sets up two or more zones, All customers within a given zone pay a single total price; the more distant the zone, the higher the price. Basing-point pricing – Pricing in which the seller designates some city as a basing point and charges all customers the freight cost from that city to the customer. Using basing-point pricing, the seller selects a given city as a basing point` and charges all customers the freight cost from that city to the customer location, regardless of the city from which the goods are actually shipped. Freight-absorption pricing – Pricing in which the seller absorbs all or part of the freight charges in order to get the desired business. Finally, the seller who is anxious to do business with a certain customer or geographical area might use freight-absorption pricing. Using this strategy, the seller absorbs all or part of the actual freight charges in order to get the desired business. The seller might1 reason that if it can get more business, its average costs will fall and more than compensate for its extra freight cost. Freight-absorption pricing is used for market penetration and to hold on to increasingly competitive markets. Dynamic and online pricing Dynamic pricing – Adjusting prices continually to meet the characteristics and needs of individual customers and situations. Throughout most of histor y, prices were set by negotiation between buyers and sellers. A fixed-price policy-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, many companies are now reversing the fixed pricing trend. They are using dynamic pricing - adjusting prices continually to meet the character- istics and needs of individual customers and situations. Dynamic pricing offers many advantages for marketers. For example, online sellers such as Amazon can mine their databases to gauge a specific shopper's desires, measure his or her means, check out competitors prices, and instantaneously tailor offers to fit that shoppers situation and behaviour, pricing products accordingly. Services ranging from retailers, airlines, and hotels to sports teams change prices on the fly according to changes in demand, costs, or competitor pricing, adjusting what they charge for specific items on a daily, hourly, or even continuous basis, Done well, dynamic pricing can help sellers to opitimize sales and serve customers better. However, done poorly, it can trigger margin-eroding price wars and damage customer relationships and trust. Companies must be careful not to cross the fine line between smart dynamic pricing strategies and damaging ones (see Real Marketing). Dynamic pricing doesn't happen only online. And it makes sense in many contexts- it adjusts prices according to market forces and consumer preferences. But marketers need to be careful not to use dynamic pricing to take advantage of customers, thereby damaging impor- tant customer relationships. Customers may resent what they see as unfair pricing practices or price gouging. For example. consumers reacted badly to reports that Coca-C Cola was proposing smart vending machines that would adjust prices depending on outside temperatures. And an Amazon.com dynamic pricing experiment that varied prices by purchase occasion received highly unfavourable headlines. Just as dynamic and online pricing benefit sellers, however, they also benefit consumers. Consumers can get instant product and price comparisons from thousands of vendors at price comparison sites or using mobile apps. Such information puts pricing power into the hands of consumers. Most store retailers must now devise strategies to deal with the consumer practice of show- rooming. Consumers armed with smartphones now routinely visit stores to see an item, compare prices online while in the store, and then request price matches or simply buy the item online at a lower price. Such behaviour is called showrooming because consumers use retailers' stores as de facto showrooms' for online resellers such as Amazon.com. Store retailers are now implementing strategies to combat such showrooming and cross-channel shopping or even turn it into an advantage, e.g. by letting physical store buyers pay the same price as on the web. At the e end of the day, with free shipping and often also free returns, the online channel may not be more profitable than a physical store where buyers may be inspired to buy more and more expensive products than they do online, where price matters more. 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 and buyers regardless of geographic location get substantial discounts. If Boeing didn't, there would be brokers earning money from the arbitrage profits that mig ht be made. 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 develop- ment of the wholesaling and retailing system. Consumer perceptions and preferences may also 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. For example, costs play an important role in setting international prices. Travellers abroad are often surprised to find that goods that are relatively inexpensive at home may carry outra- geously higher price tags in other countries. A pair of Levi's selling for sek 300 in Canada might gO for SEK 800 in Europe, and a Gucci handbag going for only seK 8,000 in Milan, Italy, might fetch sE k 14,500 in Brazil. In some cases, such price escalation may result from differences in selling strategies or market conditions. In most instances, however, it is simply a result of the higher costs of selling in another country the additional costs of product modifications, shipping and insurance, import tariffs and taxes, exchange-rate fluctuations and physical distribution. Price changes When and how should company change its price? What if costs rise, putting the squeeze on profits? What if the economy sags and customers become more price-sensitive? Or what ifa major competitor raises or drops its prices? After developing their pricing structures and strategies, companies often face situations in which they must initiate price changes or respond to price changes by competitors. Initiating price changes In some cases, the company may find it desirable to initiate either a price cut or a price increase. In both cases, it must anticipate possible buyer and competitor reactions. Initiating price cuts Several situations may lead a firm to consider cutting its price. One such circumstance is excesS capacity. Another is falling demand in the face of strong price competition In such cases, the firm may aggressively cut prices to boost sales and share. But as the airline, fast- food, car and other industries have learned in recent years, cutting prices in an industry loaded with excess capacity may lead to price wars as competitors try to hold on to market shares. Air tickets are a typical example where consumers can buy very cheap tickets on routes with intensive competition - while prices are oten high on routes with limited competition. Industry production capacity can't be controlled by a single firm-think again about the expanding air travel industry and thus attempts to bring supply and demand into balance are likely to result in a loss in market shares. Initiating price increases A successful price increase can greatly improve profits. For example, if the company's profit margin is 3 per cent of sales, a 1 per cent price increase will boost profits by 33 per cent if sales volume is unaffected. A major factor in price increases is cost inflation. Rising costs squeeze profit margins and lead companies to pass coSt increases along to customers. Another factor leading to price increases iS excessive demand: when a company cannot supply all that its customers need, it may raise its prices, ration products to customers, or both. When raising prices the company must avoid being perceived as a price gouger. For example, facing rapidly rising petrol prices, angry customers are accusing the major oil companies of enriching themselves at the expense of consumers, Customers have long memories, and they will eventually turn away from companies or even whole industries that they perceive as charging excessive prices. Claims of price gouging may even bring about increased government regulation. Consider the oil industry: are rapidly rising gas prices justified, or are the oil companies unfairly lining their pockets by gouging consumers who have feW alternatives? The Swedish Competition Authority has taken action against the oil industry, and they are likely to step in if they find that companies are harming price competition. As a core element of our free market economy, companies are usually not free to charge whatever prices they wish. Many laws govern the rules of fair play in pricing. There are some techniques foI avoiding these problems. One is to maintain a sense of fairness surrounding any price increase. Price increases should be supported by company communi- cations telling customers why prices are being raised. Making low-visibility price moves first is also a good technique: some examples include dropping discounts, increasing minimum order sizes, and curtailing production of low- margin products. The company sales force should help business customers find ways to economize. Buyer reactions to price changes Customers do not always interpret price changes in a straightforward way. A price increase, which would normally lower sales, may have some positive meanings for buyers. For example, what would you think if Rolex raised the price of its latest watch model? On the one hand, you might think that the watch is even more exclusive or better made. On the other hand, you might think that Rolex is simply being greedy by charging what the market will bear. Similarly, consumers may view a price cut in several ways. For example, what would you think if Rolex were to suddenly cut its prices? You might think that you are getting a better deal on an exclusive product. More likely, however, you'd think that quality had been reduced, and the brand's luxury image might be tarnished. A brand's price and image are often closely linked. A price change, especially a drop in price, can adversely affect how consumers view the brand. Competitor reactions to price changes A firm considering a price change must worry about the reactions of its competitors as well as those of its customers. Competitors are most likely to react when the number of firms involved is small, when the product is uniform, and when the buyers are well informed about products and prices. How can the firm anticipate the likely reactions ofits competitors? The problem iS complex because, like the customer, the competitor can interpret a company price cut in many ways. It might think the company is trying to grab a larger market share, or that it's doing poorly and trying to boost its sales. Or it might think that the company wants the whole industry to cut prices to increase total demand Responding to price changes Here we reverse the question and ask how a firm should respond to a price change by a competitor. The firm needs to consider several issues. Why did the competitor change the price? Is the price change temporary or permanent? What will happen to the company's market share and profits ifit does not respond? Are other competitors going to respond? Besides these issues, the company must also consider its own situation and strategy and possible customer reactions to price changes. Figure 11.7 shows the ways a company might assess and respond to a competitor's price cut. Suppose the company learns that a competitor has cut its price and decides that this price cut is likely to harm company sales and profits. It mig ht simply decide to hold its current price and profit margin. The company might believe that it will not lose too much market share, or that it would lose too much profit if it reduced its own price. Or it might decide that it should wait and respond when it has more information on the effects of the competitor's price change. If the company decides that effective action can and should be taken, it might make any of four responses. First, it could reduce its price to match the competitor's price. It may decide that the market is price: sensitive and that i it would lose too much market share to the lower- priced competitor. Some companies might also reduce their product quality, services and marketing communications to retain profit margins, but this will ultimately hurt long-term market share. Alternatively, the company might maintain itS price but raise the perceived value of its offer. It could improve its communications, stressing the relative value of its product over that of the lower priced competitor. The firm may find it cheaper to maintain price and spend money tO improve its perceived value than to cut price and operate at a lower margin. Or, the company might improve quality and increase price, moving its brand into a higher price-value position. Finally, the company might launch a low-price fighting brand'- adding lower- price item to the line or creating a separate lower- price brand. This is necessary if the particular market segment being lost is price-sensitive and will not respond to arg uments of higher quality. SUMMARY This chapter looks at internal and external consid- erations that affect pricing decisions and examines general pricing approaches. Despite the increased role of non-price factors in the modern marketing process, price remains an important element in the marketing mix. Good pricing begins with a complete under- standing of the value that a product or service creates for customers and setting a price that captures that value. Customer perceptions of the product's value set the ceiling for prices. Value-based pricing uses buyers' perceptions of value, not the seller's cost, as the key to pricing. The price the company charges will fall somewhere between one that is too high to produce any demand and one that is too low to produce a profit. Whereas customer perceptions of value set the celiling for prices, company and product costs set the floor. Cost- based pricing involves seting prices based on the costs for producing, distributing and selling the product plus a fair rate of return for effort and risk. However, cost- based pricing is product-driven rather than customer. driven. If the price turns out to be too high, the company must settle for lower mark-ups or lower sales, both resulting in disappointing profits. The company must watch its costs carefully. lf it costs the company more than it costs competitors to produce and sell its product, the company must charge a higher price or make less profit, putting it at a competitive disadvan- tage. To price wisely, management also needs to know how its costs vary with different levels of production and accumulated production experience. Cost-based pricing approaches include cost-plus pricing and break- even pricing (or target profit pricing). Other internal factors that influence pricing decisions include the company's overall marketing strategy, objectives, mix and organization for pricing. Price is only one element of the company's broader marketing strategy. If the company has selected its target market and positioning carefully, then its marketing mix strategy, including price, will be fairly straightforward. Some companies position their products on price and then tailor other marketing mix decisions to the prices they want to charge. Other companies de-emphasize price and use other marketing mix tools to create non-price positions. Common pricing objectives might include survival, current profit maximization, market share leadership, or customer retention and relationship building. Price deci- sions must be coordinated with product design, distri- bution and prormotion decisions to form a consistent and effective marketing programme Other external pricing considerations include the nature of the market and demand, competitors' strategies and prices, and environmental factors such as the economy, reseller needs and government actions. The seller's pricing freedom varies with different types of markets, but in general terms the customer decides whether the company has set the rig ht price So the company must understand concepts such as demand curves (the price- demand relationship) and price elasticity (consumer sensitivity to prices). Companies' pricing structures change, e.g. as a product passes through its life cycle. The company can decide on one of several price-quality strategies for intro- ducing an imitative product, including premium pricing, economy pricing, good value or overcharging. In pricing innovative new products, it can use market-skimming pricing by initially setting high prices to skim the maximum amount of revenue from various segments of the market. Or it can use market-penetrating pricing by setting a low initial price to penetrate the market deeply and win a large market share. Companies apply a variety of price adjustment strate- gies to account for differences in consumer segments and situations. One is discount and allowance pricing, whereby the company establishes cash, quantity, functional or seasonal discounts, or varying types of allowances. A second strategy is segmented pricing, where the company sells a product at two or more prices to accommodate different customers, product forms, locations or times. Sometimes companies consider more than economics in their pricing decisions, using psychological pricing to better communicate a product's intended position. In promotional pricing, a company offers discounts or temporarily sells a product below list price on a special occasion, sometimes even selling below cost as a loss leader. Another approach is geographical pricing, whereby the company decides how to price to distant customers, choosing from such alternatives as FoB-origin pricing, uniform-delivered pricing, zone pricing, basing-point pricing and freight- absorption pricing. Finally, international pricing means that the company adjusts its price to meet different conditions and expectations in different world markets. When a firm considers initiating a price change, it must consider customers' and competitors' reactions. There are different implications to initiating price cuts and initiating price increases. Buyer reactions to price changes are influenced by the meaning customers see in the price change. Competitors' reactions flow from a set reaction policy or a fresh analysis of each situation. Key terms Allowance Basing-point pricing Break-even pricing (target profit pricing) By-product pricing Captive-product pricing Cost-based pricing Cost-plus pricing Demand curve Discount Dynamic pricing Experience curve (learning curve) FOB-origin pricing Freight-absorption pricing Geographical pricing Good-value pricing Market-penetration pricing Market-skimming pricing Optional-product pricing ls Price Price elasticity Product bundle pricing Product line pricing Promotional pricing Psychological pricing Reference prices Segmented pricing Target costing Uniform-delivered pricing Value-added pricing Value-based pricing Zone pricing

Kotler 2020, Chapter 11 - Pricing Strategies PDF

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