Pricing Strategy MARK 30043 PDF

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES Department of Marketing Management College of Business Administration Main Campus MARK 30043 Pricing Strategy Compiled by: As...

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES Department of Marketing Management College of Business Administration Main Campus MARK 30043 Pricing Strategy Compiled by: Asst. Prof. Estelita E. Medina  Pricing Strategy MARK 30043 Compiled by: Asst. Prof. Estelita E. Medina ALL RIGHTS RESERVED. No part of this learning module may be reproduced, used in any form, or by any means graphic, electronic, or mechanical, including photocopying, recording, or information storage and retrieval system without written permission from the authors and the University. Published and distributed by: Polytechnic University of the Philippines address website email Tel. No.:  The VMPGO VISION PUP: The National Polytechnic University MISSION Ensuring inclusive and equitable quality education and promoting lifelong learning opportunities through a re-engineered polytechnic university by committing to: provide democratized access to educational opportunities for the holistic development of individuals with a global perspective. offer industry-oriented curricula that produce highly skilled professionals with managerial and technical capabilities and a strong sense of public service for nation-building. embed a culture of research and innovation. continuously develop faculty and employees with the highest level of professionalism. engage public and private institutions and other stakeholders for the attainment of social development goals. establish a strong presence and impact in the international academic community. PHILOSOPHY As a state university, the Polytechnic University of the Philippines believes that: Education is an instrument for the development of the citizenry and for the enhancement of nation-building; and, That meaningful growth and transformation of the country are best achieved in an atmosphere of brotherhood, peace, freedom, justice and nationalist-oriented education imbued with the spirit of humanist internationalism. SHARED VALUES AND PRINCIPLES 1. Integrity and Accountability 2. Nationalism 3. Sense of Service 4. Passion for Learning and Innovation 5. Inclusivity 6. Respect for Human Rights and the Environment 7. Excellence 8. Democracy GOALS OF THE COLLEGE/CAMPUS 1. Educate future leaders and community builders through activities that improve business practices through experiential learning opportunities and strategic partnerships. 2. Provide undergraduate and graduate programs that will equip students to become successful business professionals in an increasingly challenging and diverse business environment grounded in academic excellence, knowledge creation, quality, integrity, accountability, innovative programs and ideas, and commitment to foster lifelong learning. 3. Provide high-quality, innovative instruction on business administration in a supportive environment that encompasses exemplary teaching, experiential learning, external engagement, and impactful action-oriented, relevant, and responsive research. 4. Deliver industry-responsive curricula tailor-fitted to the needs of the industry. 5. Strengthen industry-academe-government partnerships; linkages and alliances with national and international institutions to continuously adopt best practices, advanced technologies and strategies enabling the college to produce future-proof graduates resilient to fast-paced business environment. COURSE DESCRIPTION This course will draw students to understand the price of a value exchanged for products and services, for particular brands, substitutes, store brands, and alternatives. Companies today face a fast-changing pricing environment. Value-seeking customers have put increased pricing pressure on many companies. The course points out the importance of pricing strategy to the business and how it affects the consumers. It discusses the objectives, theories, strategies, and policies. INSTITUTIONAL LEARNING OUTCOMES (ILOS) As a polytechnic state university, PUP shall develop its students to possess: 1. Critical and Creative Thinking. Graduates use their rational and reflective thinking as well as innovative abilities to life situations in order to push boundaries, realize possibilities, and deepen their interdisciplinary, multidisciplinary, and/or transdisciplinary understanding of the world. 2. Effective Communication. Graduates apply the four macro skills in communication (reading, writing, listening, and speaking), through conventional and digital means, and are able to use these skills in solving problems, making decisions, and articulating thoughts when engaging with people in various circumstances. 3. Strong Service Orientation. Graduates exemplify strong commitment to service excellence for the people, the clientele, industry and other sectors. 4. Adept and Responsible Use or Development of Technology. Graduates demonstrate  optimized and responsible use of state-of-the-art technologies of their profession. They possess digital learning abilities, including technical, numerical, and/or technopreneurial skills. 5. Passion for Lifelong Learning. Graduates perform and function in society by taking responsibility in their quest for further improvement through lifelong learning. 6. Leadership and Organizational Skills. Graduates assume leadership roles and become leading professionals in their respective disciplines by equipping them with appropriate organizational skills. 7. Personal and Professional Ethics. Graduates manifest integrity and adherence to moral and ethical principles in their personal and professional circumstances. 8. Resilience and Agility. Graduates demonstrate flexibility and the growth mindset to adapt and thrive in the volatile, uncertain, complex and ambiguous (VUCA) environment. 9. National and Global Responsiveness. Graduates exhibit a deep sense of nationalism as it complements the need to live as part of the global community where diversity is respected. They promote and fulfill various advocacies for human and social development. PROGRAM LEARNING OUTCOMES (PLOS) 1. Demonstrate the capability to articulate and implement marketing theories and concepts in professional and personal settings, locally and abroad. 2. Communicate effectively through oral, written, and digital means marketing ideas anchored on ethical standards. 3. Utilize research tools and results in analyzing the business environment and development of marketing plans and strategies to address market needs and contribute to nation development. 4. Display leadership skills and the capability to work independently and with groups. 5. Demonstrate adaptability and willingness to continuously learn from colleagues, industry, markets, and other relevant sectors. 6. Conduct business research responsive to the market environment. COURSE LEARNING OUTCOMES (CLOS). At the end of this course, the students are expected to: 1. Understand the key economic, analytical, and behavioral concepts associated with costs, customer behavior, and competition. 2. Understand the nature of price and be able to apply pricing strategies and techniques in various market conditions. 3. Comprehend and have a clear understanding of pricing strategies of different products,  lifecycles, and companies. 4. Understand and analyze price strategies of competitors in indifferent market situations through case study scenarios. 5. Appreciate and uphold the policies of pricing in the Philippine market and context.  Introduction This instructional material seeks to facilitate understanding of the whole picture of pricing strategy, see how the correct management of prices significantly impacts the definite difference in the firms' or organizations' revenues and income; and appreciate the management of prices as a way of getting a comprehensive understanding of cost and consumers. A description of what the following topics include will be broad and the key ideas related to pricing will also be mentioned in the following topics. Much of pricing's definition and the variety of objectives is integrated in topic 1 to 5, major pricing strategies, pricing strategies for new products, pricing mix strategies, and lastly, price adjustment strategies. Topics 6 to 11 looks into pricing under different market conditions, the social and legal aspects, customers' perception on price, a briefing of the core issues concerning launch and defense of price changes, limitations that prevent ranges of prices that a firm can offer and also introduces the arguments on transfer pricing as well as compete bid pricing. In light of the learning-teaching activities that are proposed in this course, the students are required to provide answers to all the activities/ assessments at the end of each topic.  TABLE OF CONTENTS Title Page The VMPGO 2 Introduction 6 Table of Contents 7 UNIT I Lesson 1 – Introduction to Price 11 a. Introduction b. Learning Objectives/Outcomes 6 c. Presentation/Discussion of the Lesson 6 d. Link to Video Lesson e. Activity Lesson 2 – Pricing Strategies 32 a. Introduction b. Learning Objectives/Outcomes 16 c. Presentation/Discussion of the Lesson 16 d. Link to Video Lesson e. Activity 16 Lesson 3 – New Product Pricing Strategies 46 a. Introduction b. Learning Objectives/Outcomes c. Presentation/Discussion of the Lesson d. Link to Video Lesson e. Activity Lesson 4 – Product Mix Pricing Strategies 55 a. Introduction b. Learning Objectives/Outcomes 27 c. Presentation/Discussion of the Lesson 27 d. Link to Video Lesson e. Activity 27 35 36 Lesson 5 – Price Adjustment Strategies 60 a. Introduction b. Learning Objectives/Outcomes 59 c. Presentation/Discussion of the Lesson 59 d. Link to Video Lesson e. Activity 59 Lesson 6 – Pricing Under Various Market Condition 71 a. Introduction b. Learning Objectives/Outcomes 72 c. Presentation/Discussion of the Lesson 72 d. Link to Video Lesson e. Activity 72 Lesson 7 – Public Policy and Marketing 77 a. Introduction b. Learning Objectives/Outcomes 89 c. Presentation/Discussion of the Lesson 89 d. Link to Video Lesson e. Activity 8 Lesson 8 – Determining Demand – Customer Perception of Price 84 a. Introduction 10 b. Learning Objectives/Outcomes 10 c. Presentation/Discussion of the Lesson d. Link to Video Lesson 10 e. Activity 1 Lesson 9 – Price Changes 92 a. Introduction 10 b. Learning Objectives/Outcomes 10 c. Presentation/Discussion of the Lesson d. Link to Video Lesson 10 e. Activity 12 Lesson 10 – Identifying Pricing Constraints 98 a. Introduction 10 b. Learning Objectives/Outcomes 10 c. Presentation/Discussion of the Lesson d. Link to Video Lesson 10 e. Activity 12 Lesson 11 – Legacy of Pricing Policies 105 a. Introduction 10 b. Learning Objectives/Outcomes 10 c. Presentation/Discussion of the Lesson d. Link to Video Lesson 10 e. Activity 12 Reference List 130 COURSE OUTCOMES At the end of the semester, the student will be able to: Understand the nature of price and pricing strategy. Gain insights on pricing under various market conditions. Appreciate the policies of pricing in our economic development. Uphold Filipino values in the practice of marketing.  TOPIC 1 – INTRODUCTION TO PRICE OVERVIEW The price paid for products and services goes by many names. You pay tuition for your education, rent for an apartment, interest on a bank credit card, and a premium for car insurance. Your dentist or physician charges you a fee, professional or social organization charges dues, and airlines charge a fare. In business, an executive is given a salary, a salesperson receives a commission, and a worker is paid a wage. And what you pay for clothes, or a haircut is termed a price. Among all marketing and operations factors in a business firm, price has a unique role. It is the place where all other business decisions come together. The price must be right in the sense that customers must be willing to pay it; it must generate enough sales dollars to pay for the cost of developing, producing, and marketing the product; and it must earn a profit for the company. Small changes in price can have big effects on both the number of units sold and company profit. LEARNING OUTCOMES After successful completion of this module, you should be able to: Discuss and explain the concept of price, the importance of pricing in today ‘s fast- changing environment. Recognize the objectives a firm has in setting prices. Identify and explain the pricing process. COURSE MATERIALS TOPIC 1 – INTRODUCTION TO PRICE Definition of Price Pricing Objectives Pricing Process DEFINITION OF PRICE All products and services have a price, just as they have a value. Many non-profit and all profit-making organizations must also set prices. Price is the amount of money charged for a product or a service. More broadly, price is the sum of all the values that customers give up gaining the benefits of having or 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. However, price still remains one of the most important elements that determine 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. Some managers view pricing as a big headache, preferring instead to focus on other marketing mix elements. However, smart managers treat pricing as a key strategic 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 increase in profitability. More importantly, as part of a company‘s overall value proposition, price plays a key role in creating customer value and building customer relationships The Price Equation For most products, money is exchanged. However, the amount paid is not always the same as the list, or quoted, price because of discounts, allowances, and extra fees. One new 21st century pricing tactic involves using ―special fees and ―surcharges. This practice is driven by consumers zeal for low prices combined with the ease of making price comparisons on the Internet. Buyers are more willing to pay extra fees than a higher list price, so sellers use add -on charges as a way of having the consumer pay more without raising the list price. All the factors that increase or decrease the final price of an offering help construct a price equation, which is shown for a few products in Figure 1.1.  Figure 1.1 Price Equation The price a buyer pays can take different names depending on what is purchased, and it can change depending on the price equation. Price as an Indicator of Value From a consumer‘s standpoint, price is often used to indicate value when it is compared with perceived benefits such as the quality or durability of a product or service. Specifically, value is the ratio of perceived benefits to price, or Value = Perceived benefits Price This relationship shows that for a given price, as perceived benefits increase, value increases. For example, if you‘re used to paying $7.99 for a medium frozen cheese pizza, wouldn‘t a large one at the same price be more valuable? Conversely, for a given price, value decreases when perceived benefits decrease. Using Value Pricing: Creative marketers engage in value pricing, the practice of simultaneously increasing product and service benefits while maintaining or decreasing price. For some products, price influences consumers perception of overall quality and ultimately its value to them. In a survey of home furnishing buyers, 84 percent agreed with the statement:  The higher the price, the higher the quality. In this context, value involves the judgment by a consumer of the worth of a product relative to substitutes that satisfy the same need. Through the process of comparing the costs and benefits of substitute items, a reference value emerges. Price in the Marketing Mix Pricing is a critical decision made by a marketing executive because price has a direct effect on a firm‘s profits. Profit equation is the profit equals total revenue minus total cost. This is apparent from a firm‘s profit equation, where: Profit = Total revenue - Total cost = (Unit price × Quantity sold) - (Fixed cost + Variable cost) What makes this relationship even more complicated is that price affects the quantity sold, as illustrated with demand curves later in this chapter. Furthermore, since the quantity sold usually affects a firm‘s costs because of efficiency of production, price also indirectly affects costs. Thus, pricing decisions influence both total revenue (sales) and total cost, which makes pricing one of the most important decisions marketing executives faces. The Importance of Price Price means one thing to the consumer and something else to the seller. To the consumer, it is the cost of something. To the seller, price is revenue, the primary source of profits. In the broadest sense, price allocates resources in a free-market economy. With so many ways of looking at price, it‘s no wonder that marketing managers find the task of setting prices a challenge. The Sacrifice Effect of Price: Price is, again, is given up, which means what is sacrificed to get a good or service. In the United States, the sacrifice is usually money, but can be other things as well. It may also be time lost while waiting to acquire the good or service. Standing in long lines at the airport first to check in and then to get through the security checkpoint procedures is a cost. In fact, these delays are one reason more people are selecting alternative modes of transportation for relatively short trips. Price might also include lost dignity for individuals who lose their jobs and must rely on charity to obtain food and clothing. For a college student, paying tuition might mean skipping a vacation, buying a less luxurious car, or waiting longer to buy a first house.  The Information Effect of Price: Consumers do not always choose the lowest priced product in a category, such as shoes, cars, or wine, even when the products are otherwise similar. One explanation of this, based upon research, is that we infer quality information from price. That is, higher quality equals higher price. The information effect of price may also extend to favorable price perceptions by others because higher prices can convey the prominence and status of the purchaser to other people. Value Is Based upon Perceived Satisfaction: Consumers are interested in obtaining a reasonable price. Reasonable price really means to perceived reasonable value at the time of the transaction. Remember, the price paid is based on the satisfaction consumers expect to receive from a product and not necessarily the satisfaction they actually receive. Price can relate to anything with perceived value, not just money. When goods and services are exchanged, the trade is called barter. For example, if you exchange this book for a chemistry book at the end of the term, you have engaged in barter. The price you paid for the chemistry book was this textbook. The Importance of Price to Marketing Managers Prices are the key to revenues, which in turn are the key to profits for an organization. Revenue is the price charged to customers multiplied by the number of units sold. Revenue is what pays for every activity of the company: production, finance, sales, distribution, and so on. What‘s left over (if anything) is profit. Managers usually strive to charge a price that will earn a fair profit. Price × Units = Revenue To earn a profit, managers must choose a price that is not too high or too low, a price that equals the perceived value to target consumers. If, in consumers‘ minds, a price is set too high, the perceived value will be less than the cost, and sales opportunities will be lost. Many mainstream purchasers of cars, sporting goods, CDs, tools, wedding gowns, and computers are buying used or pre-owned items to get a better deal. Pricing a new product too high may give some shoppers an incentive to go to a pre-owned or consignment retailer. Lost sales mean lost revenue. Conversely, if a price is too low, the consumer may perceive it as a great value, but the firm loses the revenue it could have earned. Trying to set the right price is one of the most stressful and pressure-filled tasks of the marketing manager, as trends in the consumer market attest.  Confronting a flood of new products, potential buyers carefully evaluate the price of each one against the value of existing products. The increased availability of bargain-priced private and generic brands has put downward pressure on overall prices. Many firms are trying to maintain or regain their market share by cutting prices. The Internet has made comparison shopping easier. In the organizational market, where customers include both governments and businesses, buyers are also becoming more price sensitive and better informed. Computerized information systems enable the organizational buyer to compare price and performance with great ease and accuracy. Improved communication and the increased use of direct marketing and computer- aided selling have also opened up many markets to new competitors. Finally, competition in general is increasing, so some installations, accessories, and component parts are being marketed as indistinguishable commodities. PRICING OBJECTIVES To survive in today‘s highly competitive marketplace, companies need pricing objectives that are specific, attainable, and measurable. Realistic pricing goals then require continual monitoring to determine the effectiveness of the company‘s strategy. Pricing objectives can be divided into three categories: profit oriented, sales oriented, and status quo. Profit-Oriented Pricing Objectives Profit-oriented pricing objectives include profit maximization, satisfactory profits, and target return on investment. Profit Maximization means setting prices so that total revenue is as large as possible relative to total costs. Profit maximization does not always signify unreasonably high prices, however. Both price and profits depend on the type of competitive environment a firm face, such as whether it is in a monopoly position (being the only seller) or in a much more competitive situation. Also, remember that a firm cannot charge a price higher than the product‘s perceived value. Sometimes managers say that their company is trying to maximize profits—in other words, trying to make as much money as possible. Although this goal may sound impressive to stockholders, it is not good enough for planning.  In attempting to maximize profits, managers can try to expand revenue by increasing customer satisfaction, or they can attempt to reduce costs by operating more efficiently. A third possibility is to attempt to do both. Some companies may focus too much on cost reduction at the expense of the customer. Lowe‘s lost market share when it cut costs by reducing the number of associates on the floor. Customer service declined and so did revenue. When firms rely too heavily on customer service, however, costs tend to rise to unacceptable levels. United States’ airlines used to serve full meals on two-hour flights and offered pillows and blankets to tired customers. This proved to be unsustainable. A company can maintain or slightly cut costs while increasing customer loyalty through customer service initiatives, loyalty programs, customer relationship management programs, and allocating resources to programs that are designed to improve efficiency and reduce costs. Satisfactory profits are a reasonable level of profits. Rather than maximizing profits, many organizations strive for profits that are satisfactory to the stockholders and management— in other words, a level of profits consistent with the level of risk an organization faces. In a risky industry, a satisfactory profit may be thirty-five percent. In a low-risk industry, it might be seven percent. Target Return on Investment. The most common profit objective is a target return on investment (ROI), sometimes called the firm‘s return on total assets. ROI measures management‘s overall effectiveness in generating profits with the available assets. The higher the firm‘s ROI, the better off the firm is. Many companies use a target ROI as their main pricing goal. In summary, ROI is a percentage that puts a firm‘s profits into perspective by showing profits relative to investment. A company with a target ROI can predetermine its desired level of profitability. The marketing manager can use the standard, such as ten percent ROI, to determine whether a particular price and marketing mix are feasible. In addition, however, the manager must weigh the risk of a given strategy even if the return is in the acceptable range. Sales-Oriented Pricing Objectives Sales-oriented pricing objectives are based on market share as reported in dollar or unit sales. Firms strive for either market share or to maximize sales.  Market share is a company‘s product sales as a percentage of total sales for that industry. Sales can be reported in dollars or in units of product. It is very important to know whether market share is expressed in revenue or units because the results may be different. Consider four companies competing in an industry with 2,000 total unit sales and total industry revenue of $4,000 as shown in Table 1.1. Table 1.1 Two Ways to Measure Market Share (Units and Revenue) Company A has the largest unit market share at 50 percent, but it has only 25 percent of the revenue market share. In contrast, Company D has only a 15 percent unit share but the largest revenue share: 30 percent. Usually, market share is expressed in terms of revenue and not units. Many companies believe that maintaining or increasing market share is an indicator of the effectiveness of their marketing mix. Larger market shares have indeed often meant higher profits, thanks to greater economies of scale, market power, and the ability to compensate top-quality management. Conventional wisdom also says that market share and ROI are strongly related. For the most part they are; however, many companies with low market share survive and even prosper. To succeed with a low market share, companies often need to compete in industries with slow growth and few product changes—for instance, industrial supplies. Otherwise, they must vie in an industry that makes frequently bought items, such as consumer convenience goods.  The conventional wisdom about market share and profitability is not always reliable, however. Because of extreme competition in some industries, many market share leaders either do not reach their target ROI or actually lose money. Procter & Gamble switched from market share to ROI objectives after realizing that profits do not automatically follow from a large market share. Sales Maximization Rather than strive for market share, sometimes companies try to maximize sales. A firm with the objective of maximizing sales ignores profits, competition, and the marketing environment as long as sales are rising. If a company is strapped for funds or faces an uncertain future, it may try to generate a maximum amount of cash in the short run. Management‘s task when using this objective is to calculate which price–quantity relationship generates the greatest cash revenue. Sales maximization can also be effectively used on a temporary basis to sell off excess inventory. It is not uncommon to find Christmas cards, ornaments, and other seasonal items discounted at 50 to 70 percent off retail prices after the holiday season has ended. Maximization of cash should never be a long-run objective because cash maximization may mean little or no profitability. Status Quo Pricing Objectives Status Quo Pricing Objectives seeks to maintain existing prices or to meet the competition‘s prices. This third category of pricing objectives has the major advantage of requiring little planning. It is essentially a passive policy. Often, firms competing in an industry with an established price leader simply meet the competition‘s prices. These industries typically have fewer price wars than those with direct price competition. In other cases, managers regularly shop competitors‘ stores to ensure that their prices are comparable. Status quo pricing often leads to suboptimal pricing. This occurs because the strategy ignores customers‘ perceived value of both the firm‘s goods or services and those offered by its competitors. Status quo pricing also ignores demand and costs. Although the policy is simple to implement, it can lead to a pricing disaster. PRICING PROCESS Setting the right price on a product is a four-step process, as illustrated in Figure 1.2. Figure 1.2 Steps in Setting the Right Price on a Product Establish Pricing Goals The first step in setting the right price is to establish pricing goals. Recall that pricing objectives fall into three categories: profit oriented, sales oriented, and status quo. These goals are derived from the firm‘s overall objectives. A good understanding of the marketplace and of the consumer can sometimes tell a manager very quickly whether a goal is realistic. All pricing objectives have trade-offs that managers must weigh. A profit maximization objective may require a bigger initial investment than the firm can commit to or wants to commit to. Reaching the desired market share often means sacrificing short-term profit because without careful management, long-term profit goals may not be met. Meeting the competition is the easiest pricing goal to implement. But can managers really afford to ignore demand and costs, the life cycle stage, and other considerations? When creating pricing objectives, managers must consider these trade-offs in light of the target customer, the environment, and the company‘s overall objectives. Estimate Demand, Costs, and Profits Total revenue is a function of price and quantity demanded and that quantity demanded depends on elasticity. Elasticity is a function of the perceived value to the buyer relative to the price. The types of questions managers consider when conducting marketing research on demand and elasticity are key. Some questions for market research on demand and elasticity are: What price is so low that consumers would question the product‘s quality? What is the highest price at which the product would still be perceived as a bargain? What is the price at which the product is starting to be perceived as expensive? What is the price at which the product becomes too expensive for the target market? After establishing pricing goals, managers should estimate total revenue at a variety of prices. This usually requires marketing research. Next, they should determine corresponding costs for each price. They are then ready to estimate how much profit, if any, and how much market share can be earned at each possible price. Managers can study the options in light of revenues, costs, and profits. In turn, this information can help determine which price can best meet the firm‘s pricing goals. Choose a Price Strategy to help determine a Base Price The basic, long-term pricing framework for a good or service should be a logical extension of the pricing objectives. The marketing manager‘s chosen price strategy defines the initial price and gives direction for price movements over the product life cycle. The price strategy sets a competitive price in a specific market segment based on a well-defined positioning strategy. Changing a price level from premium to super premium may require a change in the product itself, the target customers served, the promotional strategy, or the distribution channels. A company‘s freedom in pricing a new product and devising a price strategy depends on the market conditions and the other elements of the marketing mix. If a firm launches a new item resembling several others already on the market, its pricing freedom will be restricted. To succeed, the company will probably have to charge a price close to the average market price. In contrast, a firm that introduces a totally new product with no close substitutes will have considerable pricing freedom.  Companies that do serious planning when creating a price strategy usually select from three basic approaches: price skimming, penetration pricing, and status quo pricing a. Price skimming is sometimes called a ―market plus approach to pricing because it denotes a high price relative to the prices of competing products. The term price skimming is derived from the phrase ―skimming the cream off the top. Price skimming is a pricing policy whereby a firm charges a high introductory price, often coupled with heavy promotion. Companies often use this strategy for new products when the product is perceived by the target market as having unique advantages. Often companies will use skimming and then lower prices over time. This is called “sliding down the demand curve.” Manufacturers sometimes maintain skimming prices throughout a product‘s life cycle. Price skimming works best when there is strong demand for a good or service. Apple, for example, uses skimming when it brings out a new iPhone or Watch. As new models are unveiled, prices on older versions are normally lowered. Firms can also effectively use price skimming when a product is well protected legally, when it represents a technological breakthrough, or when it has in some other way blocked the entry of competitors. Managers may follow a skimming strategy when production cannot be expanded rapidly because of technological difficulties, shortages, or constraints imposed by the skill and time required to produce a product (such as fine china, for example). A successful skimming strategy enables management to recover its product development costs quickly. Even if the market perceives an introductory price as too high, managers can lower the price. Firms often believe it is better to test the market at a high price and then lower the price if sales are too slow. Successful skimming strategies are not limited to products. Well-known athletes, lawyers, and celebrity hairstylists are experts at price skimming. Naturally, a skimming strategy will encourage competitors to enter the market. Penetration pricing is at the opposite end of the spectrum from skimming. Penetration pricing means a pricing policy whereby a firm charges a relatively low price for a product when it is first rolled out as a way to reach the mass market is first rolled out as a way to reach the mass market. The low price is designed to capture a large share of a substantial market, resulting in lower production costs. If a marketing manager has made obtaining a large market share the firm‘s pricing objective, penetration pricing is a logical choice.  Penetration pricing does mean lower profit per unit, however. Therefore, to reach the break-even point, it requires a higher volume of sales than would a skimming policy. The recovery of product development costs may be slow. As you might expect, penetration pricing tends to discourage competition. A penetration strategy tends to be effective in a price-sensitive market. Price should decline more rapidly when demand is elastic because the market can be expanded through a lower price. If a firm has a low fixed cost structure and each sale provides a large contribution to those fixed costs, penetration pricing can boost sales and provide large increases in profits—but only if the market size grows or if competitors choose not to respond. Low prices can attract additional buyers to the market. The increased sales can justify production expansion or the adoption of new technologies, both of which can reduce costs. And, if firms have excess capacity, even low-priced business can provide incremental dollars toward fixed costs. Penetration pricing can also be effective if an experience curve will cause costs per unit to drop significantly. The experience curve proposes that per-unit costs will go down as a firm‘s production experience increases. Manufacturers that fail to take advantage of these effects will find themselves at a competitive cost disadvantage relative to others that are further along the curve. The big advantage of penetration pricing is that it typically discourages or blocks competition from entering a market. The disadvantage is that penetration means gearing up for mass production to sell a large volume at a low price. If the volume fails to materialize, the company will face huge losses from building or converting a factory to produce the failed product. Status Quo Pricing is the third basic price strategy a firm may choose is status quo pricing. Recall that this pricing strategy means charging a price identical to or very close to the competition‘s price. Although status quo pricing has the advantage of simplicity, its disadvantage is that the strategy may ignore demand or cost or both. If the firm is comparatively small, however, meeting the competition may be the safest route to long- term survival.  Fine-tune the base price with pricing tactics Tactics for Fine-Tuning the Base Price After managers understand both the legal and the marketing consequences of price strategies, they should set a base price—the general price level at which the company expects to sell the good or service. The general price level is correlated with the pricing policy: above the market (price skimming), at the market (status quo pricing), or below the market (penetration pricing). The final step, then, is to fine-tune the base price. Fine-tuning techniques are approaches that do not change the general price level. They do, however, result in changes within a general price level. These pricing tactics allow the firm to adjust for competition in certain markets, meet ever-changing government regulations, take advantage of unique demand situations, and meet promotional and positioning goals. Fine- tuning pricing tactics include various sorts of discounts, geographic pricing, and other pricing strategies. a. Discounts, Allowances, Rebates, and Value-Based Pricing A base price can be lowered through the use of discounts and the related tactics of allowances, rebates, low or zero percent financing, and value-based pricing. Managers use the various forms of discounts to encourage customers to do what they would not ordinarily do, such as paying cash rather than using credit, taking delivery out of season, or performing certain functions within a distribution channel. The following are the most common tactics: Quantity discounts: When buyers get a lower price for buying in multiple units or above a specified dollar amount, they are receiving a quantity discount. A cumulative quantity discount is a deduction from list price that applies to the buyer‘s total purchases made during a specific period; it is intended to encourage customer loyalty. In contrast, a noncumulative quantity discount is a deduction from list price that applies to a single order rather than to the total volume of orders placed during a certain period. It is intended to encourage orders in large quantities. Cash discounts: A cash discount is a price reduction offered to a consumer, an industrial user, or a marketing intermediary in return for prompt payment of a bill. Prompt payment saves the seller carrying charges and billing expenses and allows the seller to avoid bad debt.  Functional discounts: When distribution channel intermediaries, such as wholesalers or retailers, perform a service or function for the manufacturer, they must be compensated. This compensation, typically a percentage discount from the base price, is called a functional discount (or trade discount). Functional discounts vary greatly from channel to channel, depending on the tasks performed by the intermediary. A seasonal discount is a price reduction for buying merchandise out of season. It shifts the storage function to the purchaser. Seasonal discounts also enable manufacturers to maintain a steady production schedule year-round. Gambled price discounts: The customer receives a discount based upon the outcome of a probabilistic gamble (and which is therefore uncertain). Discounts involving uncertainty have been growing in popularity recently. Sears‘ Super Scratch event involved customers receiving a scratch-and-save card that granted savings up to $500. After paying, the cashier scratched the card to reveal the discount. This is similar to a roll-the-dice discount, which involves paying for the item and then rolling dice to determine the discount. Several apparel chains (such as Jack Jones and Mustang Jeans) and restaurants (such as Hooters) have conducted roll-the-dice campaigns. Research shows that regular price discounts can create expectations of lower prices. This can have a negative impact on profitability. Gambled price discounts, however, tend not to create long-run expectations of lower prices. A promotional allowance (also known as a trade allowance) is a payment to a dealer for promoting the manufacturer‘s products. It is both a pricing tool and a promotional device. As a pricing tool, a promotional allowance is like a functional discount. If, for example, a retailer runs an ad for a manufacturer‘s product, the manufacturer may pay half the cost. A rebate is a cash refund given for the purchase of a product during a specific period. The advantage of a rebate over a simple price reduction for stimulating demand is that a rebate is a temporary inducement that can be taken away without altering the basic price structure. A manufacturer that uses a simple price reduction for a short time may meet resistance when trying to restore the price to its original, higher level. Coupons: A coupon is a discount offered via paper, a card, a printable web page, or an electronic code. U.S. marketers issue more than 310 billion coupons each year, 2.75 billion of which are redeemed. This redemption rate of less than 1 percent has held steady for many years. Zero percent financing: To get consumers into automobile showrooms, manufacturers sometimes offer zero percent financing, which enable purchasers to borrow money to pay for new cars with no interest charge. This tactic creates a huge increase in sales, but is not without its costs. A five-year interest-free car loan typically represents a loss of more than $3,000 for the car‘s manufacturer.  Free shipping: Free shipping is another method of lowering the price for purchasers. However, since shipping is an expense to the seller, it must be built into the cost of the product. Amazon spends about $6.6 billion on shipping but brings in only about $3.1 billion in payments for shipping. Amazon, Best Buy, and Gap recently raised their minimum order requirements to receive free shipping. Value-based pricing, also called value pricing, is a pricing strategy that has grown out of the quality movement. Value-based pricing starts with the customer, considers the competition and associated costs, and then determines the appropriate price. Value- based pricing means setting the price at a level that seems to the customer to be a good price compared to the prices of other options. The basic assumption is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers. Because very few firms operate in a pure monopoly, however, a marketer using value- based pricing must also determine the value of competitive offerings to customers. Customers determine the value of a product (not just its price) relative to the value of alternatives. In value-based pricing, therefore, the price of the product is set at a level that seems to the customer to be a good price compared with the prices of other options. Research has found that loyal customers become even more loyal when they receive discounts. Also, customers who are loyal because of superior service and quality is less likely to bargain over price. b. Geographic Pricing Because many sellers ship their wares to a nationwide or even a worldwide market, the cost of freight can greatly affect the total cost of a product. Sellers may use several different geographic pricing tactics to moderate the impact of freight costs on distant customers. The following methods of geographic pricing are the most common: FOB origin pricing: FOB origin pricing, also called FOB factory or FOB shipping point, is a price tactic that requires the buyer to absorb the freight costs from the shipping point (free on board). The farther buyers are from sellers, the more they pay, because transportation costs generally increase with the distance merchandise is shipped. Uniform delivered pricing: If the marketing manager wants total costs, including freight, to be equal for all purchasers of identical products, the firm will adopt uniform delivered pricing, or ―postage stamp‖ pricing. With uniform delivered pricing, the seller pays the actual freight charges and bills every purchaser an identical, flat freight charge. This is sometimes called postage stamp pricing because a person can send a letter across the street or across the country for the same price.  Zone pricing: A marketing manager who wants to equalize total costs among buyers within large geographic areas—but not necessarily all of the seller‘s market area— may modify the base price with a zone pricing tactic. Zone pricing is a modification of uniform delivered pricing. Rather than using a uniform freight rate for the entire United States (or its total market), the firm divides it into segments or zones and charges a flat freight rate to all customers in a given zone. Freight absorption pricing: In freight absorption pricing, the seller pays all or part of the actual freight charges and does not pass them on to the buyer. The manager may use this tactic in intensely competitive areas or as a way to break into new market areas. Basing-point pricing: With basing-point pricing, the seller designates a location as a basing point and charges all buyers the freight cost from that point, regardless of the city from which the goods are shipped. Thanks to several adverse court rulings, basing- point pricing has waned in popularity. Freight fees charged when none were actually incurred, called phantom freight, have been declared illegal. c. Other Pricing Tactics Unlike geographic pricing, other pricing tactics are unique and defy neat categorization. Managers use these tactics for various reasons—for example, to stimulate demand for specific products, to increase store patronage, and to offer a wider variety of merchandise at a specific price point. Such pricing tactics include a single-price tactic, flexible pricing, professional services pricing, price lining, leader pricing, bait pricing, odd– even pricing, price bundling, and two-part pricing. Single-Price Tactic: A merchant using a single price tactic offers all goods and services at the same price (or perhaps two or three prices). Flexible Pricing: Flexible pricing (or variable pricing) means that different customers pay different prices for essentially the same merchandise bought in equal quantities. This tactic is often found in the sale of shopping goods, specialty merchandise, and most industrial goods except supply items. Car dealers and many appliance retailers commonly follow the practice. It allows the seller to adjust for competition by meeting another seller‘s price. Thus, a marketing manager with a status quo pricing objective might readily adopt the tactic. Flexible pricing also enables the seller to close a sale with price-conscious consumers. The obvious disadvantages of flexible pricing are the lack of consistent profit margins, the potential ill will of high-paying purchasers, the tendency for salespeople to automatically lower the price to make a sale, and the possibility of a price war among sellers.  Professional Services Pricing is used by people with lengthy experience, training, and often certification by a licensing board—for example, lawyers, physicians, and family counselors. Professionals sometimes charge customers at an hourly rate, but sometimes fees are based on the solution of a problem or performance of an act (such as an eye examination) rather than on the actual time involved. Those who use professional pricing have an ethical responsibility not to overcharge a customer. Because demand is sometimes highly inelastic, such as when a person requires heart surgery to survive, there may be a temptation to charge ―all the traffic will bear. Price Lining: When a seller establishes a series of prices for a type of merchandise, it creates a price line. Price lining is the practice of offering a product line with several items at specific price points. Wireless providers use price lining for cell phones that are purchased with a two-year contract. Price lining reduces confusion for both the salesperson and the consumer. The buyer may be offered a wider variety of merchandise at each established price. Price lines may also enable a seller to reach several market segments. For buyers, the question of price may be quite simple: all they have to do is find a suitable product at the predetermined price. Moreover, price lining is a valuable tactic for the marketing manager, because the firm may be able to carry a smaller total inventory than it could without price lines. The results may include fewer markdowns, simplified purchasing, and lower inventory carrying charges. Price lines also present drawbacks, especially if costs are continually rising. Sellers can offset rising costs in three ways. First, they can begin stocking lower-quality merchandise at each price point. Second, sellers can change the prices, although frequent price line changes confuse buyers. Third, sellers can accept lower profit margins and hold quality and prices constant. This third alternative has short-run benefits, but its long-run handicaps may drive sellers out of business. Leader Pricing (or loss-leader pricing) is an attempt by the marketing manager to attract customers by selling a product near or even below cost in the hope that shoppers will buy other items once they are in the store. This type of pricing appears weekly in the newspaper advertising of supermarkets. Leader pricing is normally used on well-known items that consumers can easily recognize as bargains. Leader pricing is not limited to products. Health clubs offer a one-month free trial as a loss leader. Bait Pricing: In contrast to leader pricing, which is a genuine attempt to give the consumer a reduced price, bait pricing is deceptive. Bait pricing tries to get consumers into a store through false or misleading price advertising and then uses high-pressure selling to persuade them to buy more expensive merchandise. You may have seen this ad or a similar one: This is bait. When a customer goes in to see the machine, a salesperson says that it has just been sold or else shows the prospective buyer a piece of junk. Then the salesperson says, ―But I‘ve got a really good deal on this fine new model. This is the switch that may cause a susceptible consumer to walk out with a $400  machine. The Federal Trade Commission considers bait pricing a deceptive act and has banned its use in interstate commerce. Most states also ban bait pricing, but sometimes enforcement is lax. Odd–Even Pricing (or psychological pricing) means pricing at odd numbered prices to connote a bargain and pricing at even-numbered prices to imply quality. For years, many retailers have priced their products in odd numbers— for example, $99.95—to make consumers feel they are paying a lower price for the product. Even-numbered pricing is often used for prestige items, such as a fine perfume at $100 a bottle or a good watch at $1,000. The demand curve for such items would also be saw-toothed, except that the outside edges would represent even numbered prices and, therefore, elastic demand. Price Bundling is marketing two or more products in a single package for a special price. For example, Microsoft offers ―suites of software that bundle spreadsheets, word processing, graphics, e-mail, Internet access, and groupware for networks of microcomputers. Price bundling can stimulate demand for the bundled items if the target market perceives the price as a good value. Services like hotels and airlines sell a perishable commodity (hotel rooms and airline seats) with relatively fixed costs. Bundling can be an important income stream for these businesses because the variable costs tend to be low—for instance, the cost of cleaning a hotel room. To account for this variability, hotels sometimes charge a resort fee that covers things like use of the gym, pool, and Wi-Fi. Bundling is also widely used in the telecommunications industry. Companies offer local service, long distance, DSL Internet service, wireless, and even cable television in various bundled configurations. Telecom companies use bundling as a way to protect their market share and fight off competition by locking customers into a group of services. For consumers, comparison shopping may be difficult since they may not be able to determine how much they are really paying for each component of the bundle. You inevitably encounter bundling when you go to a fast food restaurant. McDonald‘s Happy Meals and Value Meals are bundles, and customers can trade up these bundles by super sizing them. Super sizing provides a greater value to the customer and creates more profits for the fast food chain. Two-Part Pricing means establishing two separate charges to consume a single good or service. Consumers sometimes prefer two part pricing because they are uncertain about the number and the types of activities they might use at places like an amusement park. Also, the people who use a service most often pay a higher total price. Two-part pricing can increase a seller‘s revenue by attracting consumers who would not pay a high fee even for unlimited use.  For example, a health club might be able to sell only 100 memberships at $700 annually with unlimited use of facilities, for a total revenue of $70,000. However, it could sell 900 memberships at $200 with a guarantee of using the racquetball courts ten times a month. Every use over ten would require the member to pay a $5 fee. Thus, membership revenue would provide a base of $180,000, with some additional usage fees throughout the year. Pay What You Want: To many people, paying what you want or what you think something is worth is a very risky tactic. Obviously, it would not work for expensive durables like automobiles. Imagine someone paying $1 for a new BMW! Yet this model has worked in varying degrees in digital media marketplaces, restaurants, and other service businesses. Social pressures can come into play in a pay what you want environment because an individual does not want to appear poor or cheap to his or her peers. Package Content Reduction: Manufacturers can keep the price and package size the same while reducing the amount of content, thereby increasing the price per ounce or pound. Consumer Penalties: More and more businesses are adopting consumer penalties—extra fees paid by consumers for violating the terms of a purchase agreement. Airlines often charge a fee for changing a return date on a ticket. Businesses impose consumer penalties for two reasons: they will allegedly (1) suffer an irrevocable revenue loss and/or (2) incur significant additional transaction costs should customers be unable or unwilling to complete their purchase obligations. For the company, these customer payments are part of doing business in a highly competitive marketplace. With profit margins in many companies increasingly coming under pressure, organizations are looking to stem losses resulting from customers not meeting their obligations. Some medical professionals charge a penalty fee if you don‘t show up for an appointment. However, the perceived unfairness of a penalty may affect some consumers‘ willingness to patronize a business in the future. Link to reference video lesson: https://youtu.be/sF6AMj3H0jg?si=3jY_xrAmePgAiDCo https://youtu.be/T2MWJK0EWqw?si=ukS9pGDXyyYOzs9s ACTIVITIES/ ASSESSMENTS 1. What is price? Define in your own words. 2. What is the importance of pricing? Explain. 3. Identify and discuss the different categories of pricing objectives. 4. What is the four-step process of pricing? Explain each step.  TOPIC 2 – PRICING STRATEGIES OVERVIEW Setting the right price is one of the marketer‘s most difficult tasks. A host of factors come into play. But finding and implementing the right price strategy is critical to success. 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 2.1 summarizes the major considerations in setting price. Customer perceptions of the product‘s value set the ceiling for prices. If customers perceive that the product‘s price is greater than its value, they will not buy the product. Product costs set the floor for prices. If the company prices the product below its costs, the company‘s profits will suffer. In setting its price between these two extremes, the company must consider several internal and external factors, including competitors‘ strategies and prices, the overall marketing strategy and mix, and the nature of the market and demand. Figure 2.1 suggests three major pricing strategies: customer value-based pricing, cost based pricing, and competition-based pricing Figure 2.1 Major Pricing Strategies LEARNING OUTCOMES After successful completion of this module, you should be able to: Identify and discuss the three major pricing strategies, the importance of understanding customer-value perceptions, company costs, and competitor strategies when setting prices. COURSE MATERIALS TOPIC 2 – PRICING STRATEGIES Customer-value based Pricing Cost-based Pricing Competition-based Pricing CUSTOMER-VALUE BASED PRICING In the end, the customer will decide whether a product‘s price is right. Pricing decisions, like other marketing mix decisions, must start with customer value. When customers buy a product, they exchange something of value (the price) to get something of value (the benefits of having or using the product). Effective, customer-oriented pricing involves understanding how much value consumers place on the benefits they receive from the product and setting a price that captures this value. Customer value-based pricing sets price by using buyers‘ perceptions of value, not the seller‘s cost, as the key to pricing. Value-based pricing means that the marketer cannot design a product and marketing program and then set the price. Price is considered along with all other marketing mix variables before the marketing program is set. The comparison between value- based pricing with cost-based pricing is shown in Figure 2.1. Although costs are an important consideration in setting prices, cost-based pricing is often product driven. 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 a 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 markups 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 drive decisions about what costs can be incurred and the resulting product design. As a result, pricing begins with analyzing consumer needs and value perceptions, and the price is set to match perceived value. It‘s important to remember that ―good value is not the same as low price. 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 value to other satisfactions such as taste, environment, relaxation, conversation, and status is very hard. Such value is subjective; it varies 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. According to an old Russian proverb, there are two fools in every market—one who asks too much and one who asks too little. 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 1. Good-Value Pricing Recent economic events have caused a fundamental shift in consumer attitudes toward price and quality. In response, many companies have changed their pricing approaches to bring them in line with changing economic conditions and consumer price perceptions. More and more, marketers have adopted good-value pricing strategies— offering the right combination of quality and good service at a fair price. In many cases, this has involved introducing less-expensive versions of established, brand-name products. To meet tougher economic times and more frugal consumer spending habits, fast-food restaurants such as Taco Bell and McDonald‘s offer value meals and dollar menu items. Armani offers the less-expensive, more-casual Armani Exchange fashion line. Alberto-Culver‘s TRESemmé hair care line promises ―A salon look and feel at a fraction of the price.‖ And every car company now offers small, inexpensive models better suited to the strapped consumer‘s budget.  In other cases, good-value pricing has involved redesigning existing brands to offer more quality for a given price or the same quality for less. Some companies even succeed by offering less value but at rock-bottom prices. For example, passengers flying the low- cost European airline Ryanair won‘t get much in the way of free amenities, but they‘ll like the airline‘s unbelievably low prices. An important type of good-value pricing at the retail level is everyday low pricing (EDLP). EDLP involves charging a constant, everyday low price with few or no temporary price discounts. Retailers such as Costco and the furniture seller Room & Board practice EDLP. The king of EDLP is Walmart, which practically defined the concept. Except for a few sale items every month, Walmart promises everyday low prices on everything it sells. In contrast, high-low pricing involves charging higher prices on an everyday basis but running frequent promotions to lower prices temporarily on selected items. Department stores such as Kohl‘s and Macy‘s practice high-low pricing by having frequent sales days, early-bird savings, and bonus earnings for store credit-card holders. 2. Value-Added Pricing Value-based pricing doesn‘t mean simply charging what customers want to pay or setting low prices to meet competition. Instead, 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. For example, at a time when competing restaurants lowered their prices and screamed value in a difficult economy, fast-casual chain Panera Bread has prospered by adding value and charging accordingly. COST-BASED PRICING 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 and Walmart, 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. However, other companies—such as Apple, BMW, and Steinway— intentionally pay higher costs so that they can claim higher prices and margins. For example, it costs more to make a ―handcrafted Steinway piano than a Yamaha production model. But the higher costs result in higher quality, justifying that eye-popping $72,000 price. The key is to manage the spread between costs and prices—how much the company makes for the customer value it delivers. Types of Costs A company‘s costs take two forms: fixed and variable. Fixed costs (also known as overhead) are costs that do not vary with production or sales level. For example, a company must pay each month‘s bills for rent, heat, interest, and executive salaries—whatever the company‘s output. Variable costs vary directly with the level of production. Each PC produced by HP involves a cost of computer chips, wires, plastic, packaging, and other inputs. Although these costs tend to be the same for each unit produced, they are called variable costs because the total varies with the number of units produced. Total costs are the sum of the fixed and variable costs for any given level of production. Management wants to charge a price that will at least cover the total production costs at a given level of production. The company must watch its costs carefully. If it costs the company more than its competitors to produce and sell a similar product, the company will need to charge a higher price or make less profit, putting it at a competitive disadvantage. Costs at Different Levels of Production To price wisely, management needs to know how its costs vary with different levels of production. For example, suppose Texas Instruments (TI) built a plant to produce 1,000 calculators per day. Figure 2.2A shows the typical short-run average cost curve (SRAC). It shows that the cost per calculator is high if TI‘s factory produces only a few per day. But as production moves up to 1,000 calculators per day, the average cost per unit decreases. This is because fixed costs are spread over more units, with each one bearing a smaller share of the fixed cost. TI can try to produce more than 1,000 calculators 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.  Figure 2.2 Cost per Unit at Different Levels of Production per Period If TI believed it could sell 2,000 calculators 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 2,000 calculators 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 2.2B). In fact, a 3,000- capacity plant would be even more efficient, according to Figure 2.2B. 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 2.2B 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 Texas Instruments (TI) runs a plant that produces 3,000 calculators per day. As TI gains experience in producing calculators, it learns how to do it better. Workers learn shortcuts and become more familiar with their equipment. With practice, the work becomes better organized, and TI finds better equipment and production processes. With higher volume, TI becomes more efficient and gains economies of scale. As a result, the average cost tends to decrease with accumulated production experience. This is shown in Figure 2.3. Thus, the average cost of producing the first 100,000 calculators is $10 per calculator. When the company has produced the first 200,000 calculators, the average cost has fallen to $8.50. After its accumulated production experience doubles again to 400,000, the average cost is $7. This drop in the average cost with accumulated production experience is called the experience curve (or the learning curve).  Figure 2.3 Cost per Unit as a Function of Accumulated Production: The Experience Curve 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 fall faster if the company makes and sells more during a given time period. But the market has to stand ready to buy the higher output. And to take advantage of the experience curve, TI must get a large market share early in the product‘s life cycle. This suggests the following pricing strategy: TI should price its calculators low; its sales will then increase, and its costs will decrease through gaining more experience, and then it can lower its prices further. Some companies have built successful strategies around the experience curve. However, 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 The simplest pricing method is cost-plus pricing (or markup pricing)—adding a standard markup to the cost of the product. Construction companies, for example, submit job bids by estimating the total project cost and adding a standard markup for profit. Lawyers, accountants, and other professionals typically price by adding a standard markup to their costs. Some sellers tell their customers they will charge cost plus a specified markup; for example, aerospace companies often price this way to the government. To illustrate markup pricing, suppose a toaster manufacturer had the following costs and expected sales:  Variable cost $10 Fixed costs $300,000 Expected unit sales 50,000 Then the manufacturer‘s cost per toaster is given by the following: unit cost = variable cost + fixed costs = $10 + $300,000 = $16 unit sales 50,000 Now suppose the manufacturer wants to earn a 20 percent markup on sales. The manufacturer‘s markup price is given by the following: markup price unit cost = $16 = $20 = (1 - desired return on sales) 1-2 The manufacturer would charge dealers $20 per toaster and make a profit of $4 per unit. The dealers, in turn, will mark up the toaster. If dealers want to earn 50 percent on the sales price, they will mark up the toaster to $40 ($20 50% of $40). This number is equivalent to a markup on cost of 100 percent ($20/$20). Does using standard markups 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, markup 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. Second, when all firms in the industry use this pricing method, prices tend to be similar, so price competition is minimized. Third, many people feel that cost-plus pricing is 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 Another cost-oriented pricing approach is break-even pricing (or a variation called target return pricing). Break-even pricing (target return pricing) Setting price to break even on the costs of making and marketing a product or setting price to make a target return. The firm tries to determine the price at which it will break even or make the target return it is seeking. Target return pricing uses the concept of a break-even chart, which shows the total cost and total revenue expected at different sales volume levels. Figure 2.4 shows a breakeven chart for the toaster manufacturer discussed here. Fixed costs are $300,000 regardless of sales volume. Variable costs are added to fixed costs to form total costs, which rise with volume. Figure 2.4 Break-Even Chart for Determining Target-Return Price and Break-Even 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 $20 per unit. The total revenue and total cost curves cross at 30,000 units. This is the break-even volume. At $20, 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 = $300,000 = = 30,000 price - variable cost $20 - $10 If the company wants to make a profit, it must sell more than 30,000 units at $20 each. Suppose the toaster manufacturer has invested $1,000,000 in the business and wants to set a price to earn a 20 percent return, or $200,000. In that case, it must sell at least 50,000 units at $20 each. If the company charges a higher price, it will not need to sell as many toasters to achieve its target return. But the market may not buy even this lower volume at the higher price. Much depends on 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 2.1. The table shows that as price increases, the break-even volume drops (column 2). But as price increases, the demand for toasters also decreases (column 3). At the $14 price, because the manufacturer clears only $4 per toaster ($14 less $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. Table 2.1 Break-Even Volume and Profits at Different Prices At the other extreme, with a $22 price, the manufacturer clears $12 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 $18 yields the highest profits. Note that none of the prices produce the manufacturer‘s target return of $200,000. To achieve this return, the manufacturer will have to search for ways to lower the fixed or variable costs, thus lowering the break-even volume. COMPETITION-BASED PRICING Competition-based pricing involves setting prices based on competitors‘ strategies, costs, prices, and market offerings. Consumers will base their judgments of a product‘s value on the prices that competitors charge for similar products. 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. If consumers perceive less value relative to competing products, the company must either charge a lower price or change customer perceptions to justify 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 from 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. Two Forms of Competition-Based Pricing 1. Going-rate pricing In going-rate pricing, the firm bases its price largely on competitors‘ prices, with less attention paid to its own costs or to demand. The firm might charge the same as, more, or less than its chief competitors. In oligopolistic industries that sell a commodity such as steel, paper or fertilizer, firms normally charge the same price. The smaller firms follow the leader: they change their prices when the market leader‘s prices change, rather than when their own demand or costs change. Some firms may charge a bit more or less, but they hold the amount of difference constant. Thus, minor petrol retailers usually charge slightly less than the big oil companies, without letting the difference increase or decrease. Although it gives firms little control of their revenue, going-rate pricing can be quite popular. When demand elasticity is hard to measure, firms feel that the going price represents the collective wisdom of the industry concerning the price that will yield a fair return. They also feel that holding to the going price will prevent harmful price wars. 2. Sealed-bid pricing In sealed-bid pricing, a firm bases its price on how it thinks competitors will price rather than on its own costs or on demand. Would-be suppliers can submit only one bid and cannot know the other bids. Sealed-bid auctions, where buyers submit secret bids, have always been common in business-to-business (B2B) marketing and some consumer markets. Governments also often use this method to procure supplies.  Until the advent of the Internet, haggling (one-to-one negotiations) and a non- negotiable price had grown to dominate pricing. Auctions existed in specialized markets, such as commodities, some specialized financial services, fine art and antiques. Now, led by eBay.com, online auctions for Beanie Babies and much more have become one of the most influential Internet innovations. Whereas conventional auctions needed the market to gather for an auction or have simultaneous telephone contact, the Internet‘s global reach and simultaneity are putting auctions at the centre of trading. If forecasters are correct, auctions are set to become an increasingly common part of everyone‘s life. B2B is currently the dominant form but consumer-based auctions, both B2C and C2C, are now running at an estimated a 20 billion a year. Because of the growth in popularity of auctions, especially with the growth of the Internet, companies should be aware of the array of auction-type pricing procedures. Here, we discuss sealed-bid pricing as a form of auction- type pricing as well as address recent developments in auction-type pricing. Economists see auctions as an efficient way of matching supply and demand but they do introduce uncertainty into transactions. The sellers do not know the price they will receive and buyers have no guarantee of making a purchase. One of the most common forms of auction, sealed-bid pricing, is an example. First-price sealed-bid pricing occurs in two ways. Potential buyers may be asked to submit sealed bids, and the item is awarded to the buyer who offers the highest price. Conversely, firms may have to bid for a contract to supply goods or services that is awarded to the contender with the lowest price. In sealed-bid pricing, a firm bases its bid price on how it thinks competitors will bid. To win a contract, a contender has to price below other firms. Yet the firm cannot set its price below a certain level. It cannot price below cost without harming its position. In contrast, the higher the company sets its price above its costs, the lower its chance of getting the contract. The net effect of the two opposite pulls can be described in terms of the expected profit of the particular bid as shown in Table 2.2.  Table 2.2 Effects of Different Bids on Expected Profit Suppose a bid of €9,500 would yield a high chance (say, 0.81) of getting the contract, but only a low profit (say, €100). The expected profit with this bid is therefore €81. If the firm bid €11,000, its profit would be €1,600, but its chance of getting the contract might be reduced to 0.01. The expected profit would be only €16. Thus the company might bid the price that would maximize the expected profit. According to Table 2.2, the best bid would be €10,000, for which the expected profit €216. Using expected profit as a basis for setting price makes sense for the large firm that makes many bids. In playing the odds, the firm will make maximum profits in the long run. But a firm that bids only occasionally or needs a particular contract badly will not find the expected- profit approach useful. The approach, for example, does not distinguish between a €100,000 profit with a 0.10 probability and a €12,500 profit with a 0.80 probability. Yet the firm that wants to keep production going would prefer the second contract to the first. In English auctions the price is raised successively until only one bidder remains. This is the most common auction form, familiar from scenes of rare items, be it a Van Gogh or a pair of Madonna‘s pants, being sold by one of the great auction houses, such as Sotheby‘s or Christie‘s. These have joined eBay as providers of online auctions aimed at its network of regular dealers (sothebys.com) or, for smaller collectables ($100 to $100,000), at consumers (sothebys.amazon.com). One of the largest European operators, qxl.com, operates both B2C and C2C while on holidayauctions.net customers can bid for bargain late- break holidays. In Dutch auctions prices start high and are lowered successively until someone buys. These auctions originated in the Dutch wholesale flower markets. B2B online traders, such as Bidbusiness.co.uk and constrauction.com, use both English and Dutch auctions to sell industrial products. In collective buying increasing numbers of customers agree to buy as prices are lowered to the final bargain. The more customers join in, the lower the price becomes until a minimum demand is met. Letsbuyit.com and adabra.com offer each auction over a limited period for each option, then move on to the next batch. These sites often offer batches of products, say several items of kitchen equipment that are most suited to B2B markets. In a reverse auction customers name the price that they are willing to pay for an item and seek a company willing to sell. In pioneering their online service priceline.com takes advantage of two major trends: first, most industries being in a continual state of excess capacity and, second, customers being brand neutral‘ if they can get a good deal. Most of Priceline‘s business is in travel services and mortgages but it is moving into life insurance, groceries and second-hand goods. Although economists see auctions as close to Adam Smith‘s invisible hand that drives markets, there are few cool hands at auctions. Major art auctions are social, newsworthy and exciting events. Jim Rose, of QXL, has no doubt about why online auctions are similarly popular: They‘re fun, they‘re entertaining, and people describe it as winning something rather than buying‖ it. The winner‘s curse is very apparent in some South-east Asian markets where to win, contenders pay more than high street prices. And how many people can attend an auction and not walk away with something they had no intention of buying! The second-price sealed bid method can reduce some of the stress. In this, sealed bids are submitted but the buyer pays a price equal to the second-best bid. Reference link for video lesson: https://youtu.be/Esqu08CSOwE?si=CQHflV4tm4Hy8Sok https://youtu.be/RxJ6rtP2jwk?si=S6u6_kPMbH0TP5d_ https://youtu.be/FBpG5FHR-io?si=O9h-ReJJ0iuFo2xb ACTIVITIES/ ASSESSMENTS 1. What are the three major pricing strategies? Differentiate. 2. Name and describe the two types of value-based pricing methods. 3. Discuss the importance of understanding customer-value perception. 4. What are the types of cost-based pricing and the methods of implementing each? Explain. 5. Discuss the two forms of competition-based pricing.  TOPIC 3 – NEW PRODUCT PRICING STRATEGIES OVERVIEW The specific strategies firms use to price goods and services grow out of the marketing strategies they formulate to accomplish overall organizational objectives. One firm‘s marketers may price their products to attract customers across a wide range; another group of marketers may set prices to appeal to a small segment of a larger market; still another group may simply try to match competitors‘ price tags. Pricing strategies usually change as the product passes through its life cycle. The introductory stage is especially challenging. We can distinguish between pricing a product that imitates existing products and pricing an innovative product that is patent protected. A company that plans to develop an imitative new product faces a product-positioning problem. It must decide where to position the product versus competing products in terms of quality and price. Figure 3.1 shows four possible positioning strategies. First, the company might decide to use a premium pricing strategy – producing a high- quality product and charging the highest price. At the other extreme, it might decide on an economy pricing strategy – producing a lower-quality product, but charging a low price. These strategies can coexist in the same market as long as the market consists of at least two groups of buyers, those who seek quality and those who seek price. Price High Low High Premium Strategy Good-value Strategy Quality Overchanging Strategy Economy Strategy Low Figure 3.1 Effects of Different Bids on Expected Profit  The good-value strategy represents a way to attack the premium pricer. A leading grocery chain always uses the strapline: Strapline is a slogan often used in conjunction with a brand‘s name, advertising and other promotions. Using an overcharging strategy, the company overprices the product in relation to its quality. In the long run, however, customers are likely to feel ‗taken‘. They will stop buying the product and will complain to others about it. Thus this strategy should be avoided. Companies bringing out an innovative, patent-protected product face the challenge of setting prices for the first time. They can choose between two strategies: market-skimming pricing and market-penetration pricing. LEARNING OUTCOMES After successful completion of this module, you should be able to: Identify possible positioning strategies. Describe the major strategies for pricing new products. Differentiate market-skimming and market-penetration pricing strategies. COURSE MATERIALS TOPIC 3 – NEW PRODUCT PRICING STRATEGIES Marketing - Skimming Pricing Market - Penetration Pricing MARKETING - SKIMMING PRICING Derived from the expression ―skimming the cream, skimming pricing strategies are also known as market-plus pricing. They involve intentionally setting a relatively high price compared with the prices of competing products. Although some firms continue to use a skimming strategy throughout most stages of the product lifecycle, it is more commonly used as a market-entry price for distinctive goods or services with little or no initial competition. When the supply begins to exceed demand, or when competition catches up, the initial high price is dropped.  Such was the case with high-definition televisions (HDTVs), whose average price was $19,000, including installation, when they were first introduced. The resulting sticker shock kept them out of the range of most household budgets. But nearly a decade later, price cuts have brought LCD models into the reach of mainstream consumers. At Best Buy, shoppers can pick up a Toshiba 19-inch flat-panel LCD model for $229.99. On the higher end, they can purchase a Sony Bravia 60-inch flat-panel LCD model for $2,699.99. Another example, when Apple first introduced the iPhone, its initial price was as much as $599 per phone. The phones were purchased only by customers who really wanted the sleek new gadget and could afford to pay a high price for it. Six months later, Apple dropped the price to $399 for an 8GB model and $499 for the 16GB model to attract new buyers. Within a year, it dropped prices again to $199 and $299, respectively, and you can now buy an 8GB model for $99. In this way, Apple skimmed the maximum amount of revenue from the various segments of the market. Consider another example – Intel. When Intel first introduces a new computer chip, it charges the highest price it can, given the benefits of the new chip over competing chips. It sets a price that makes it just worthwhile for some segments of the market to adopt computers containing the chip. As initial sales slowdown and as competitors threaten to introduce similar chips, Intel lowers the price to draw in the next price-sensitive layer of customers. A company may practice a skimming strategy in setting a market-entry price when it introduces a distinctive good or service with little or no competition. Or it may use this strategy to market higher-end goods. British vacuum cleaner manufacturer Dyson has used this practice. Offering an entirely new design and engineering, Dyson sells several of its vacuum cleaner models for between $400 and $600, significantly more than the average vacuum. Even the various models of iRobot‘s Roomba vacuum sell for $200 and up, and the company claims it does all the work for you. In some cases, a firm may maintain a skimming strategy throughout most stages of a product‘s lifecycle. The jewelry category is a good example. Although discounters such as Costco and Home Shopping Network (HSN) offer heavier gold pieces for a few hundred dollars, firms such as Tiffany and Cartier command prices ten times that amount just for the brand name. Exclusivity justifies the pricing—and the price, once set, rarely falls.  Sometimes maintaining a high price through the product‘s lifecycle works, but sometimes it does not. High prices can drive away otherwise loyal customers. Baseball fans may shift from attending major league games to minor league games if available because of ticket, parking, and food prices. Amusement park visitors may shy away from high admission prices and head to the beach instead. If an industry or firm has been known to cut prices at certain points in the past, consumers and retailers will expect it. If the price cut doesn‘t come, consumers must decide whether to pay the higher tab or try a competitor‘s products. Significant price changes in the retail gasoline and airline industries occur in the form of a step out, in which one firm raises prices and then waits to see if others follow suit. If competitors fail to respond by increasing their prices, the company making the step out usually reduces prices to the original level. Although airlines are prohibited by law from collectively setting prices, they can follow each other‘s example Despite the risk of backlash, a skimming strategy does offer benefits. It allows a manufacturer to quickly recover its research and development (R&D) costs. Pharmaceutical companies, fiercely protective of their patents on new drugs, justify high prices because of astronomical R&D costs: an average of 16 cents of every sales dollar, compared with 8 cents for computer makers and 4 cents in the aerospace industry. To protect their brand names from competition from lower-cost generics, drug makers frequently make small changes to their products—such as combining the original product with a complementary prescription drug that treats different aspects of the ailment. A skimming strategy also permits marketers to control demand in the introductory stages of a product‘s lifecycle and then adjust productive capacity to match changing demand. A low initial price for a new product could lead to fulfillment problems and loss of shopper goodwill if demand outstrips the firm‘s production capacity