Chapter 12 - Developing Pricing Strategies and Programs
I. Learning Objectives
After reading this chapter, students should:
q Know how consumers process and evaluate prices
q Know how a company should set prices initially for products or services
q Know how a company should adapt prices to meet varying circumstances and opportunities
q Know when a company should initiate a price change
q Know how a company should respond to a competitor’s price change

II. Chapter Summary
Despite the increased role of nonprice factors in modern marketing, price remains a critical element of the marketing mix. Price is the only element that produces revenue; the others produce costs.

In setting pricing policy, a company follows a six-step procedure. It selects its pricing objective; estimates the demand curve, the probable quantities it will sell at each possible price; estimates how its costs vary at different levels of output and of accumulated production experience, and for differentiated marketing offers; examines competitors’ costs, prices, and offers; selects a pricing method; and then selects the final price.

Companies do not usually set a single price, but rather a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, and other factors. Several price-adaptation strategies are available: (1) geographical pricing; (2) price discounts and allowances; (3) promotional pricing; and (4) discriminatory pricing.

After developing pricing strategies, firms often face situations in which they need to change prices. A price decrease might be brought about by excess plant capacity, declining market share, a desire to dominate the market through lower costs, or economic recession. A price increase might be brought about by cost inflation or overdemand. Companies must carefully manage customer perceptions toward raising prices.

Companies must anticipate competitor price changes and prepare contingent responses. A number of responses are possible in terms of maintaining or changing price or quality. The firm facing a competitor’s price change must try to understand the competitor’s intent and the likely duration of the change. Strategy often depends on whether a firm is producing homogeneous or nonhomogeneous products. A market leader attacked by lower-priced competitors can seek to better differentiate itself, introduce its own low-cost product, or transform itself more completely.

III. Chapter Outline
I. Understanding Pricing
A. A Changing Pricing Environment - today, many firms are bucking the low-price trend and have been successful in trading consumers up to more expensive products and services by combining unique formulations with engaging marketing campaigns. The Internet is partially reversing the fixed-pricing trend
B. How Companies Price
1. Size of organization influences who sets the price (i.e. owner sets this in a small organization; divisions or departments in a larger organization set this with executive management direction)
2. Industry dynamics influence structure of pricing
C. Consumer Psychology and Pricing - consumer purchase decisions are based on how they perceive price and what they consider to be the current actual price
1. Reference prices - compare to an:
a) Internal reference price (pricing information from memory)
b) External reference price (e.g. a posted “regular retail price”)
2. Price-quality references
a) Price used as an indicator of quality
b) Image pricing effective with ego-sensitive products (e.g. expensive car)
c) Alternative information about quality may reduce significance of price as a quality indicator
3. Price cues
a) Sales signs
b) “9s” - consumers tend to view figures from left to right rather than rounding them off (i.e. $299 perceived in $200 range versus $300 range)

II. Setting the Price
A. Step 1: Selecting the Pricing Objective
1. Survival
2. Maximum current profits
3. Maximum market share (market-penetration pricing)
4. Market skimming - appeals to high-end market segment
5. Product-quality leadership - premium quality connotes premium price
6. Other pricing objectives - cost recovery (partial or full) and social pricing
B. Step 2: Determining Demand
1. Price sensitivity - unique-value, substitution-awareness, difficult-comparison, total-expenditure, end-benefit, shared-cost, sunk-investment, price-quality, and inventory effects
2. Estimating demand curves - statistical analysis, price experiments, and buyer input
3. Price elasticity of demand
a) Determination of the effect of a change in price on overall demand 
b) If demand changes considerably with a change in price, it is elastic. If demand does not change significantly or in parallel with the price, it is inelastic
C. Step 3: Estimating Costs
1. Types of costs and levels of production - fixed, variable, and total costs
2. Accumulated production - learning curve pricing
3. Activity-based cost accounting - differentiated marketing offers and measures real costs of serving each customer, which leads to more accurate profitability measurement
4. Target costing - determine price that must be charged according to market research
D. Step 4: Analyzing Competitors’ Costs, Prices, and Offers (evaluate from customer perspective, compare, value and reaction)
E. Step 5: Selecting a Pricing Method
1. Markup pricing - standard markup, but can vary according to product categories
2. Target return pricing - to make a fair return on investment
3. Perceived value pricing - based on buyer perception
4. Value pricing - fairly low price for a high-quality offering, everyday low pricing, etc.
5. Going-rate pricing - base price on that of competitors (“follow the leader”)
6. Auction-type pricing - ascending, descending, and sealed-bid
F. Step 6:  Selecting Final Price 
1. The influence of other marketing activities - brand’s quality and advertising relative to the competition (know brands with high quality and high relative advertising can command higher prices)
2. The influence of other marketing-mix elements - note relationships between relative price, relative quality, and relative advertising
3. Company pricing policies - contemplated price must be consistent
4. Gain-and-risk sharing pricing - risk losing customers if cannot deliver full promised value
5. Impact of price on other parties - distributors, sales force, competitors, suppliers, government, etc.

III. Adapting the Price
A. Geographical Pricing - price by geographic location to address issues such as higher shipping costs
1. Countertrade - offer other items as payment
2. Barter - direct exchange of goods with no money or third party involved
3. Compensation deal - payment consists of a combination of products and cash
4. Buyback arrangement - sell plant or equipment and receive goods manufactured with them for partial payment
5. Offset - receive full cash payment but agree to spend much of the cash in respective geographic area within a specified time
B. Price Discounts and Allowances - cash discounts, quantity discounts, functional (trade) discounts, seasonal discounts, allowances, trade-in, or promotional discounts
C. Promotional Pricing
1. Loss-leader pricing - to stimulate traffic
2. Special event pricing - to draw customers
3. Cash rebates - to encourage purchase within a specified time
4. Low-interest financing - to facilitate purchase
5. Longer payment terms - for lower monthly payments
6. Warranties and service contracts - added value
7. Psychological discounting - set an artificially high initial price before lowering it
D. Differentiated Pricing - adjust base price to accommodate differences in customers, products, locations, etc.
1. Customer-segment pricing - different prices for different groups
2. Product-form pricing - different versions priced differently
3. Image pricing - same product at two different levels
4. Channel pricing (location pricing) - same product priced differently at different locations
5. Time pricing - same product priced differently at different time, day, or season (Yield pricing is an offer of a lower price on unsold inventory before it expires)
6. Note on price discrimination: it occurs when a company sells a product or service at different prices with no proportional difference in costs. It works when:
a) Segments show different demand intensities
b) Members in lower priced segment cannot resell product to those in higher priced segment

c) Competitors cannot undersell in higher priced segment
d) Cost of segmenting and policing the market does not exceed extra revenue derived from price discrimination
e) Practice does not breed customer resentment
f) Form of discrimination is not illegal 
E. Product-Mix Pricing
1. Product-line pricing - price steps
2. Optional-feature pricing - in addition to main product
3. Captive-product pricing - main products that require ancillary products
4. Two-part pricing - fixed fee plus variable fee based on usage
5. By-product pricing - to recoup production costs of main product
6. Product-bundling pricing - less costly when purchased together

IV. Initiating and Responding to Price Changes
A. Initiating Price Cuts  
1. Excess capacity
2. Drive to dominate the market - note: this strategy has high risks
B. Initiating Price Increases
1. Cost inflation
2. Anticipatory pricing - raise price in anticipation of higher costs
3. Overdemand - options for overdemand can include:
a) Delayed quotation pricing
b) Escalator clauses
c) Unbundling
d) Reduction of discounts
C. Responding to Competitors’ Price Changes
1. Maintain price and profit margin
2. Maintain price and add value
3. Reduce price
4. Increase price and improve quality
5. Launch low-price fighter line

V. Summary

IV. Opening Thought
Students should have a good understanding of “price” in their role as consumers. The instructor is encouraged to expand the student’s definition of price by using examples of different pricing structures (e.g. cell phone plans), promotional pricing, geographical pricing, and price discrimination.

An area of some misunderstanding for students new to marketing is how the firm reviews competitors’ reactions to price changes. Students will have some degree of difficulty in assuming the role of a competitor and formulating defensive and/or offensive plans to price changes.

Discriminatory pricing is also an area that students new to marketing might find challenging to grasp. Although discriminatory pricing is not illegal, per se, distinctions between the two are sometimes porous.

V. Teaching Strategy and Class Organization
PROJECTS
1. At this point in the semester-long marketing plan project, students should be prepared to submit their pricing strategy decisions for their fictional product/service. In reviewing this section, the instructor should ensure that students have addressed all or most of the material, concerning pricing, covered in this chapter.

2. Consumer perceptions of prices are also affected by alternative pricing strategies. Marriott Hotels, for example, has different brands for differing price points. Building upon the Marriott example, students are to scan the environment for a company whose pricing strategy is closely tied to its branding strategy. Caution: students may want to list just the different price points in the same company such as the Lexus brand of automobiles. If students are able to note that the Lexus range is priced at a premium to the Toyota range, the objective of this project would be achieved.

ASSIGNMENTS
Small Group Assignments
1. Marketers recognize that consumers often actively process price information, interpreting prices in terms of their knowledge from prior purchasing experiences, formal communications, informal communications, point-of-purchase, or online resources. Purchase decisions are based on how consumers perceive prices and what they consider to be the current actual price—not the marketer’s stated price. In small groups, ask students to choose a service good, such as education, legal advice, tax advice, or other such services, and have them map out their perception of prices and what they consider to be the current actual price. Finally, students should compare and contrast their perceptions with the stated or published prices for these services. In completing this assignment, students should explain the differences between perception and stated prices in terms of consumer buying behavior models from Chapter 5 of this text.

2. Many consumers use price as an indicator of quality. As a group assignment, students should choose a product produced by a firm. Subsequently, they should conduct a small research project (utilizing the material learned from Chapter 3) and either confirm or deny this relationship for the chosen product. For example, do more women or men rely on price as an indicator of quality for product X? If there is a difference, what is the quantifiable difference in terms of marketing research data? Does this difference suggest that marketers should revise or revamp price cues to reach their target market?

Individual Assignments

1. Table 12.1 (Factors Leading to Less Price Sensitivity) lists nine factors that the authors contend lead to less price sensitivity in consumers. Choosing a product that is available online and in stores (e.g. books or tires), students are to research the various pricings available to consumers through Internet shopping gateways and retailers. After collecting this data, they are to comment on whether the variety of price points found can raise or lower consumers’ price sensitivity to the items because of the differing prices.

Think-Pair-Share

1. For many firms, pricing is the domain of the financial disciplines in the company. Using accepted accounting and financial processes, some companies price strictly according to these models. Assign some students the assumed role of “defenders” of this practice and others as “innovators” who challenge these models and support the newer pricing models such as “perceived” and “value” pricing for products. Have the students come prepared to defend their positions using the concepts developed in this chapter. 

2. Paul W. Farris and David J. Reibstein, in their article, “How Prices, Expenditures, and Profits Are Linked,” Harvard Business Review (November-December 1979); pp. 173–184, found a relationship between relative price, relative quality, and relative advertising (their findings are summarized in the chapter). Students should read the full report, and then be prepared to discuss its validity in light of the consumer information explosion that has occurred due to the Internet’s emergence. Are these relationships still valid today? If not, what has caused them to change and why?

END-OF-CHAPTER SUPPORT
MARKETING DEBATE

How to Fight Low-Cost Rivals?

VI. Case Study
1. Marketing in China: Home Inn
1) What is the model of and the factors behind Home Inn’s success? Why can’t other economy hotels (e.g. Jinjiang Inn) achieve similar success?
2) If you were a competitor of Home Inn, how would you compete with it?
2. Chapter Case: Galanz’s strategy of low-priced competition
1) How does Galanz increase its market share rapidly? Analyze its successful model.
2) What are the differences between the price reduction strategies Galanz adopted as a market challenger and as a market leader?
3) What is the major weakness of Galanz’s price reduction strategy?

3. To prepare case studies based on the following materials from Chapter 12 and to present these:
• Mini Case: IKEA in China 
• Innovative Marketing: eBay
• Innovative Marketing: Ryanair

VII. Main Topic(s)
A. “Measuring the Impact of Price—How Important is the Pricing Variable”
This discussion deals with pricing strategy in a marketing setting, along with the role and value of effective pricing in the overall marketing strategy and implementation effort. It begins with examples of pricing problems and options as a means of maintaining or strengthening the firm’s market position. This leads into a discussion of the implications for the introduction of various pricing strategies for the firm and the industry.
It is useful to update the examples so that students will be able to identify readily with this concept based on their general knowledge of the companies and products involved in the lecture/discussion. 

    Marketing Insight: A Framework for Responding to Low-Cost Rivals

Teaching Objectives
· To stimulate students to think about the critical issues, advantages and disadvantages, for a firm when it moves toward adoption of a formal or informal pricing strategy. 
· To develop points to consider in proceeding with a specific pricing strategy.
· To better understand the role of pricing strategies and policies in helping the firm achieve a balanced position vis á vis the customer and the competition.
Discussion
Introduction
Pricing policies in many companies tend to be based more on intuition and what the market will bear than on scientific or objective criteria. However, this approach is beginning to change, in line with many other changes taking place in marketing and in the U.S. and global economies. Pricing has become a key issue for both consumer and business marketers, and sadly it is a problem area where few managers are well-prepared. Pricing is not part of most university programs, largely because it has long been considered part of the world of economics, “the dismal science”.  
Marketing professionals have tended to ignore pricing theories and concepts, and in the past they did not even consider it as an equal part of the marketing equation. Accordingly, pricing and its impact have been studied very little, but clearly it is and should be one of the more important aspects of the marketing process. To most contemporary marketing professionals, pricing is a final and very important marketing strategy focal point. Without an effective pricing analysis and price decision, the rest of the marketing process is left unfinished.
ROLE OF PRICING
Pricing can and does help a company attain its other marketing objectives. As a result, pricing strategy should be tied closely and carefully to the overall business, competitive, and marketing strategy. Further, the pricing program should be supported with a focused plan of implementation. Pricing enables the marketer to segment markets, define products, create customer incentives, and even send signals to competitors.
For example, if the company wants to enter a crowded field, such as the credit card business, it may opt for a penetration strategy. This is what Sears did with the Discover card. The retailer obtained as many customers as possible through a low price (i.e. no membership fee), and established a position in the market. Skimming would be the opposite strategy; it involves pricing a product at a high level to “skim” the innovators. That way, the firm obtains high profits at the beginning of the product life cycle, effectively covering the development costs. After the firm pays for the development costs, it has the option to move the price down to the next level to achieve other marketing objectives. Either strategy can work; but the decision, implementation, and results all depend on the firm’s marketing objectives.
Many marketing professionals argue that pricing is a valuable strategic weapon that helps companies enhance and capitalize on competitive vulnerability, and there is no question that pricing decisions have an immediate impact on a company’s bottom line. From this perspective, it is easy to argue that to a large degree, pricing decisions can determine whether a product and/or a company will succeed or fail.
PRICING LIMITS
The first thing a pricing strategy process would determine is that there is an upper and lower price boundary, and each has to be considered. The upper boundary—the economic value of the product—basically is the most an informed consumer is willing to pay for the product. Marketers determine this boundary by comparing the product with a reference product, and asking what attributes the product has that are above, or below, the value of the product offered by competitors. Clearly, if a product is below the value of the competition, it is almost impossible to set the price higher than the competitive price.
Next, the marketer should identify the best available alternative product for the most important customer market or segment. The marketer could ask: “Other than the obvious benefit, what additional benefits does this product provide?” Many times, the benefit is labor savings or additional productivity. Other times there could be emotional benefits, or some other intangible benefit. 
Once the list of benefits is completed, it is time to assign a value to each benefit. Some benefits are quantifiable directly, such as labor savings. The analyst can calculate the number of hours saved multiplied by the wage rate. If there is another specific benefit, the firm may try to determine the value. For example, the marketer may analyze possible substitute products to determine if there are other benefits related products might have that eventually prove important in the competitive process. It is appropriate to make an effort to determine the approximate value of such benefits to determine if and when prices should be adjusted. 
Another technique that can be useful in determining the upper boundary of a particular product’s price is a conjoint study, or survey, of various customers. With this approach, prospects are invited to select from a series of pricing options for the product. In the survey, the researcher attempts to determine the value of the product’s particular attributes. Once the firm has obtained this data, they have found the upper boundary of the product’s potential price.
It is critical to approach the process from the customer perspective, separating what the company thinks of the economic value and the customer’s perceived economic value. Unfortunately, some companies care so much about the product, that they consider every benefit at the high end. The result is that the survey research has to determine whether people will believe what the company believes concerning price and value. 
THE ROLE OF THE CUSTOMER 
There are many examples of the role of the customer in the pricing process, and one of the better examples comes from Datastorm, a software firm that made the ProComm Plus, an early software product that linked computers to networks through a modem. The market for this software was already beginning to grow in 1991, just when ProComm Plus was scheduled for its debut, and competing products were already on the shelves, priced at a premium. Datastorm believed that it could tap pent-up demand for lower-priced communications software in the consumer market, so the strategy was to set the price of the product at $179, dramatically less expensive than the competition. The company maintained that pricing point for four years. Datastorm dominated the field, with an 85% market share among IBM computer users, until 1996. Many analysts credit the company’s pricing strategy as the key to its success.
What the marketing managers at Datastorm did, consciously or unconsciously, was to follow a well-defined market-oriented process to pick new product prices. The focus was on the three C’s: customer, company, and competition. To employ this simple marketing tool, Datastorm managers set the price of a new product based on the customer’s perception of a fair price. Of course, the customer’s perception of what was a fair price often was based on the competitor’s price that typically the consumer perceives as on the high (economic) end of the scale. This approach can be quite useful for those selling into an established market, or even into a new market, if the measurement is performed properly.
Micromarketing also plays an important part in pricing strategy. Stores, such as the Midwestern grocer Dominick’s, engaged in micromarketing by using pricing data obtained from scanners and measured by Information Resources Inc. and ACNielsen. ACNielsen’s program measured the differences in elasticities between stores and matched prices so that customers who cared more about price got discounts, and customers who cared about other factors could receive those benefits.
To determine low-end pricing for a particular product, it is important to adopt a customer perspective. As noted above, companies often are so aware and care so much about the product that every benefit is considered at the high end in price-value. Of course, the obvious question is whether individual consumers and the marketplace have the same perception of value and price.
The marketer also must examine the variable costs, or incremental costs, that matter to the consumer. A common error is that companies consider variable costs as part of fixed costs. In an airline, if you have a seat, and you consider the average cost of the plane and the crew, it might turn out that the average cost per seat was $10. However, if the plane is sitting on the runway, ready to take off, the variable cost might be as low as $1. At this point, the differences between fixed and variable costs look very different. This is the way it is with highly perishable and time-sensitive goods and/or services. The variable cost tells you what you are gaining for each additional customer. If you raise that price too high, you likely consider additional customers less valuable than they truly are in the final analysis (such as when the plane is sitting on the runway, ready to take off). 
Firms that inflate their variable costs tend not to cut their prices very often. They do not realize the true incremental revenue they can gain from a discount. Experts advise against putting overhead costs into the price of the product because they are fixed, not variable, costs. By folding overhead costs into the equation, the firm may be distorting the pricing decision. The essence of the matter is that empty hotel rooms or plane seats are revenue never to be regained. It is better to have something than nothing. This is an attitude that has gained considerable popularity since 9/11 as the airlines and other industries watched their carefully developed strategies based on their perceptions of value go down the drain.
The relationship between the quality of a product and a particular price is always an issue. Price sensitivity research has provided much information that can help determine the relationship of price to quality. Consumers ask: “Is this better if it is more expensive?” In response, marketers apply the principles of “odd” versus “even” pricing. Research in pricing indicates that something at $9.99 versus $10 is generally associated with Sears, Kmart, and JCPenney. It puts the emphasis on the first digit. The implication or perception is that the retailer is trying to save the consumer money. If a retailer sells a Packard-Bell computer for $1,999.95, there is only a five-cent difference between that and $2,000. However, many people place emphasis on the first number. On the other side of the scale, Nordstrom and other high-end retailers price in even numbers. This lends an aura of quality to the product. There is also prestige pricing, where you effectively advertise that you have the most expensive perfume in the world. This is strictly a matter of old-fashioned snob appeal, but it can work depending on your market segment.
· THE ART OF NAMING A PRICE
After the price limits, high and low, are determined, we enter into what essentially is the “art form” of pricing, often referred to as “the art of pricing”. There are particular aspects of pricing that will determine where the firm will price, based on these upper and lower boundaries, without much price sensitivity or elasticity. Here, there are issues such as “fairness”.
Fairness is gauged by thinking about how a customer feels about the price of a product. Research shows that price increases are perceived as fair if they are based on increased costs, but those based on the characteristics and/or circumstances of the customer are considered unfair. One of the major pricing issues in recent years is that of “everyday low pricing”. This is where the retailer charges a constant, lower price at all times, with no temporary price discounts. This approach reduces uncertainty among consumers, and it helps to restore faith in the price of a brand. It also contrasts sharply with the so-called “high-low” strategy of companies that rely on constant price promotions. Discounters such as Wal-Mart led the trend toward “everyday low pricing”, but the concept generally is more popular in the southern states of the U.S. than in the northern ones.
Whatever pricing tactics the firm chooses, it is important to remember that pricing is essential to strategy and should not be treated as an afterthought. Strategic pricing should be one of a business’s most potent competitive weapons, and substantial sales potential may well be lost without an effective planning and control effort in this important area of marketing activity.

VIII. Background Article(s)
     Issue: Reference Prices
 
Source: Russell S. Winer’s, “Behavioral Perspectives on Pricing,” and “Buyer’s Subjective Perceptions of Price Revisited,” in Issues in Pricing: Theory and Research, ed. Timothy Devinney, Lexington, MA: Lexington Books, 1988, pp. 35–57.

Students should comment on whether these consumer reference prices are applicable to today’s consumers; whether this list is inclusive, or are there new consumer reference price points that have developed due to the use of the Internet?