ABMA 107 - Pricing Strategies (Lesson) PDF

Don Mariano Marcos Memorial State University North La Union Campus- Bacnotan, La Union Institute of Agribusiness Management ABMA 107 – INTRODUCTION TO MARKETING Lesson: Pricing Strategies MICHELLE ANN L. CABILADAS Faculty, Institute of Agribusiness Management What is Price Price...

Don Mariano Marcos Memorial State University North La Union Campus- Bacnotan, La Union Institute of Agribusiness Management ABMA 107 – INTRODUCTION TO MARKETING Lesson: Pricing Strategies MICHELLE ANN L. CABILADAS Faculty, Institute of Agribusiness Management What is Price Price what it costs the buyer to acquire it from the seller price is what the seller rewards for giving up its property rights on the good or service (Webster) prices represent acceptable exchange ratios for goods value expressed in terms of some exchanged commodity Price equates to the financial sacrifice that the customer is willing to make to purchase the product or service desired Why is Pricing Important? Importance of Pricing a decisive factor in agent decisions simplify evaluation of complex transactions contribute to greater efficiency in their maximization of utility represent a very compact way of summarizing information about demand/supply conditions for efficient communication The Economist’s view of Pricing the perspective of the interplay of demand and supply At a broader level, the economist views pricing decisions as an ‘allocatory’ ‘mechanism, with prices being used as the signal to solve the basic problems of an economic society: e.g. the allocation of scarce resources between competing users and individuals in that society so that resources are used in the most effective way. From the perspective of the price setter, traditional economic theory suggests that the ‘optimum’ price is one that equates marginal costs to marginal revenue so as to ‘maximize’ profits.  A framework for pricing decisions: Key Inputs Key inputs for the pricing decision-maker 1. Company and Marketing Objectives 2. Demand Considerations 3. Cost Considerations 4. Competitor Considerations 1. Company and Marketing Objectives ▪ Pricing decisions are salient to the achievement of corporate and marketing objectives, so it is essential that pricing objectives and strategies are consistent with and supportive of these objectives. Company and Marketing Objectives ▪ The potential range of pricing objectives and their relationship to overall corporate and marketing objectives : pricing to maximize long-run profits pricing to maximize short-run profits pricing to expand market share pricing to maintain a price leadership position Company and Marketing Objectives pricing to discourage potential new entrants; pricing to avoid the attention of government and legislators; pricing to establish and maintain dealer loyalty pricing to improve corporate image pricing to improve the sales of weaker products. 2. Demand considerations ▪ A key parameter affecting pricing decisions is customer based. ▪ The upper limit to the price to be charged is set by the market, unless the customer must purchase the product and we are the sole supplier. ▪ In competitive markets, demand that is, the price customers are willing and able to pay is a major consideration in the selection of pricing strategies and levels. 2. Demand considerations 2. Demand considerations ▪ Price is only one of the determinants of the demand for a product or service. ▪ Additional factors which combine to determine demand: ✓ income/budget of the purchaser ✓ attributes of the product ✓ Tastes/preferences of the purchaser ✓ price of other products ✓ the time it takes to deliver 2. Demand considerations ▪ Income/budget of the purchaser The ability of the purchaser to buy products and services according to individual’s income level and purchasing power converts the purchaser’s needs and wants into actual purchasing. Willingness to purchase as ‘effective demand’ For an organizational buyer, the ability to purchase is directly related to budget requirements and constraints set on the purchaser. 2. Demand considerations ▪ Attributes of the Product Demand for a product is closely related to how the customer perceives the various attributes of competitive products. physical/tangible attributes: quality features and packaging ‘non-tangible’ attributes: brand/corporate image and status 2. Demand considerations ▪ Tastes/Preferences of the Buyer ‘Taste’ is a powerful influence on demand. Changes in taste/preference can give rise to the growth of entirely new markets and the demise of mature ones. ‘Tastes’ can also be of an industrial nature, being associated, for example, with variables such as: an emphasis on productivity improvements, quality management and employee care and protection. 2. Demand considerations ▪ Price of other Products ▪ Buyers tend to consider prices of substitute products when evaluating the effect of prices on demand. ▪ In the case of substitute products, how the price of one item compares to the price of another is central to the selection process of the buyer. 2. Demand considerations ▪ The Time Factor demand must be specified for a given time period e.g. ‘short’, medium’ and ‘long run’ time horizons From the perspective of the pricing decision-maker, it is essential to assess the sensitivity of demand. Price elasticity of demand: effect on quantity demanded will for any given change in price 2. Demand considerations ▪ Elasticity of Demand Price elasticity of demand means demand for a product is: Inelastic if consumers will pay almost any price or the product Very elastic if consumers will only pay within a narrow band of prices. Inelastic demand means a producer can raise prices without affecting demand too much Elastic demand means consumers are price sensitive and will not buy if prices rise too much. 2. Demand considerations ▪ The demand for a product to be responsive, or not, to changes in price can be summarized as a function of: the number and closeness of substitutes the necessity of the purchase to the buyer the importance of product performance to the buyer the cost of switching suppliers. 3. Cost considerations ▪ Cost considerations determine the lower limits of price. ▪ Relevant up-to-date cost information is essential to formalize pricing strategy. ▪ Accurate information allows the pricing decision-maker to identify costs on a specific basis directly related to each product, activity or customer. 3. Cost considerations ▪ Cost analysis: should enable the marketer to distinguish between fixed and variable costs and the relationship between these and volume Fixed costs: those that do not vary with levels of output Variable costs: directly relate to production and sales and include labor and direct materials. Increases in output or sales lead to a proportional increase in these costs. ▪ Taken together, fixed and variable costs combine to give total costs. 3. Cost considerations ▪ Cost analysis Breakeven point – the point at which total revenue exactly matches the total costs, that is, there is neither profit nor loss. This information on cost/revenue relationships is useful to the pricing decision-maker when comparing breakeven points associated with different possible prices for a product. 3. Cost considerations ▪ Cost analysis Breakeven point 3. Competitor considerations Competition is at the core of the success or failure of firms. Competition determines the appropriateness of a firm’s activities that can contribute to its performance, such as innovations, a cohesive culture, or good implementation. Competitive advantage is the benefit derived through competitive strategy aimed at establishing a profitable and sustainable position against the forces that determine industry competition. – Michael E. Porter 3. Competitor considerations Most important considerations with regard to competitor pricing: competitors’ prices, including discounts, credit terms and terms of trade; competitors’ resources, especially financial competitors’ costs and profit margins likely competitor responses to pricing strategies and decisions likely potential competitors and barriers to market industry entry substitutes from other industries competitor marketing strategies: targeting, positioning and product differentiation 3. Competitor considerations Important competitor considerations which directly affect the extent to which an industry will be price competitive are: the number of competitors the degree of product differentiation between competitors freedom of entry Pricing Methods Pricing Methods Basis for Price Setting: 1. Internal cost-based methods 2. Competitor-based methods 3. Customer value-based methods Pricing Methods 1. Internal cost-based methods of pricing Also referred to as “cost-plus pricing” Involves a company calculating average costs of production and then allocating a specified mark-up, which may be related to the rate of return required by the company, to arrive at the selling price. The major advantage of this method is its simplicity. Pricing Methods 1. Internal cost-based methods of pricing Advantages: ✓ The pricing decision-maker does not have to consider the difficult (if essential) area of demand and price sensitivity. ✓ Where other companies are using cost-plus pricing, and provided they have similar costs and mark ups, it can lead to price stability. ✓ It is claimed that because prices are directly related to costs it is ‘fair’ to both competitors and customers. Pricing Methods 1. Internal cost-based methods of pricing Disadvantages: it ignores demand and market conditions it ignores competitors and competitive considerations it ignores factors such as target marketing and positioning it ignores potential substitutes Pricing Methods ▪ Variants of Internal cost-based methods of pricing: a. Marginal or direct cost pricing - where prices are based not on full costs that include fixed costs but on direct or marginal costs. Pricing Methods ▪ Variants of Internal cost-based methods of pricing: b. Variable mark-up pricing - an alternative to the fixed mark-up system of traditional cost-plus pricing, and here the percentage added to costs can be varied. ▪ Advantages over the fixed mark-up approach: mark-up, and hence prices, can be varied to take account of demand, competition and market conditions; mark-up can take account of marketing objectives and strategies; Over-all it represents a much more flexible approach. Pricing Methods 2. Competition-based pricing A method of determining a price uses the price set by competitors to orient the pricing decision Based on an assumption that the product image and the position of the company are the same or similar to those of the competition Pricing Methods 2. Competition-based pricing Example: The marketer may, for example, set a price 5 per cent below that of the market leader to allow for the market leader’s stronger reputation within the industry. Pricing Methods 2. Competition-based pricing This approach to pricing has the disadvantage of being somewhat passive in nature, which tends to restrict the management of the company. Another drawback of this method, known as going rate pricing: it tends to ignore the company’s own cost and demand situation. Going rate pricing is popular in markets where costs are difficult to measure, or the response of competitors is uncertain. Pricing Methods 3. Customer value-based pricing a market-oriented method complex in nature and application moves away from a focus on costs or competition and concentrates on customers With this approach, prices are determined on the basis of the perceived value of the product to the customer. Pricing Methods 3. Customer value-based pricing When customers purchase a product, they go through a complex process of balancing benefits against costs. In consumer product markets, the ‘benefits’ the customer derives correspond to the economist’s notion of ‘utility’ or satisfaction and may include both functional and psychological elements Pricing Methods 3. Customer value-based pricing Examples: The customer may derive satisfaction, and hence value, from the quality of a product, or a particular product feature, such as a satellite navigation system built into a new car. An example of a psychological element of value might be the benefit which the customer derives from the status of a prestigious brand name. Pricing Methods 3. Customer value-based pricing ▪ Value-based pricing is useful in guiding other elements of marketing strategy: ✓ Value-based pricing can help in market segmentation and targeting, with marketing efforts being focused on those parts of the market (customer groups) where the perceived value of a company’s offering is highest. Pricing Methods 3. Customer value-based pricing ▪ Value-based pricing is useful in guiding other elements of marketing strategy: ✓ Value-based pricing can point the way to developing effective promotional and selling strategies. The customer must be made aware of, and convinced about, any extra value that your products or services can potentially offer. Pricing Methods 3. Customer value-based pricing ▪ Value-based pricing is useful in guiding other elements of marketing strategy: ✓ Value-based pricing can be used in the early stages of designing and developing new products and services with a conscious effort being made to ‘build in’ value to the product or service for the envisaged target market. Pricing Methods 3. Customer value-based pricing ▪ Value-based pricing is useful in guiding other elements of marketing strategy: ✓ Many agree that value-based pricing represents the truly marketing-oriented approach to pricing, but it is still poorly researched and understood.  Other Considerations in Setting Prices Other Considerations in Setting Prices 1. Price/quality relationships ▪ In the absence of other information, price is often used as a singular indicator of quality. ▪ The pricing decision-maker must be careful to ensure, particularly for a new product, that a low initial price does not put off customers because they suspect the quality. Other Considerations in Setting Prices 2. Psychological pricing There are behavioral forces at work with respect to price, involving psychological factors such as perception, learning and personality. These behavioral forces have led to the notion of considering the psychology of pricing processes: ▪ Odd pricing: often prices are set to end in an odd number (e.g. Php 99.99 instead of Php 100.00 Other Considerations in Setting Prices Psychological pricing ▪ Price and perceptions of quality: price is often used by potential customers as an indication of quality, particularly where they are unfamiliar with a brand or supplier. This means that a low price may be taken as a sign of low quality and vice versa, meaning that it is possible to price a product too low. Other Considerations in Setting Prices Psychological pricing ▪ Price and social status: the marketer needs to be aware that some customers will regard the prices they and other people pay as an indicator of status. This is related to price as an indicator of quality. ▪ Some customers may be deterred by low prices even if they know it represents the best possible value, because they feel it detracts from their social status. Other Considerations in Setting Prices 4. Other products in the line/mix – interrelated costs and/or demand of other products in a multi-product company 5. Other elements of the marketing mix - it is important that pricing reflects, and is consistent with, other elements of the mix Example: a high-quality, expensively packaged product may be looked at with some suspicion by potential buyers if it carries a bargain price tag. Other Considerations in Setting Prices 6. Product lifecycle The competitive situation for a product changes throughout the lifecycle of a product Pricing in the introductory stage of the lifecycle: with an innovatory product, developers can expect to have a competitive edge for a period of time. With innovative new products, a company can choose between two pricing strategies: price skimming: the setting of a high initial price that is lowered in successive stages price penetration: the setting of a low initial price. Other Considerations in Setting Prices 6. Product lifecycle Pricing in the growth stage: for a period of time after introduction the market will continue to grow. The fact that new companies are entering the market means the market will be divided between competing companies, but as the market is still growing new companies may not take any sales away from the innovator for some time. The innovating company will usually lower the price of its own product to discourage competition. Other Considerations in Setting Prices 6. Product lifecycle Pricing at the maturity stage: as the market for the product continues to expand and develop, the use of the product becomes more widespread and, with the entrance of new competitors, the price of the product will become increasingly important in competitive strategy. Other Considerations in Setting Prices 6. Product lifecycle Pricing in the decline stage: during this stage, price-cutting initiated in the maturity stage will tend to continue. At this stage, a careful appraisal of profit margins will need to be made. References: Essentials of Marketing Management (2018) G. Lancaster & L. Massingham Lectures on Agri. Marketing (2020). M. Cabiladas