Pricing Considerations and Strategies

Pricing Considerations and Strategies

Previewing the Concepts: Chapter Objectives

1. Identify and explain the external and internal factors affecting a firm’s pricing decisions.

2. Contrast the three general approaches to setting prices.

3. Describe the major strategies for pricing imitative and new products.

4. Explain how companies find a set of prices that maximizes the profits from the total product mix.

5. Discuss how companies adjust their prices to take into account different types of customers and situations.

6. Discuss the key issues related to initiating and responding to price changes.

JUST THE BASICS

Chapter Overview

Pricing is the second element in the marketing mix. It plays a powerful role, and that role is detailed in this chapter. There are several sections to this chapter and a lot of material to address.

The chapter begins with discussing what a price actually is. It makes the point that price is more than just the money the buyer hands over to the seller—the broader view is that the price is the sum of all the values that the buyer exchanges for obtaining or using the product. There is also a brief discussion of dynamic- versus fixed-price policies, and how we as a society have evolved from dynamic to fixed and back to dynamic again.

The chapter then moves into the heart of pricing. Both internal and external factors that must be considered when setting price are detailed, as are the three general pricing approaches of cost-based pricing, value-based pricing, and competition-based pricing. The new product pricing strategies of market skimming versus market penetration are also discussed.

The chapter then moves into product mix pricing strategies. Five different strategies are outlined, including the often-forgotten category of by-product pricing. Strategies for adjusting prices, such as discount and allowance pricing, segmented pricing and psychological pricing are described, as well as initiating and responding to price changes in the marketplace. Finally, the public policy implications of pricing are covered, including the major laws that pertain to pricing.

Chapter Outline

1. Introduction

a. The Internet has had a dramatic impact on pricing, particularly through Priceline.com, which is a service that lets consumers name their own prices.

b. Jay Walker, the founder of Priceline.com, reasoned that letting consumers set their own prices would benefit both the consumers and the sellers, because buyers would get lower prices and sellers would be able to turn excess inventory into profits.

c. Priceline.com is especially attractive to those who sell products that have “time sensitivity,” which is why it works so well in the travel industry. Priceline.com makes its money by buying up unsold hotel rooms, airline seats, or vacation packages at heavily discounted rates, marking them up, and selling them to consumers for as much as a 12% return.

d. The recent economic downturn has put companies in a “pricing vise.” It has been impossible to raise prices, and there is lot of pressure to slash them. But reducing prices can lead to lost profits and damaging price wars. It can signal to customers that price is more important than brand. The challenge is to find the price that will let the company make a fair profit by harvesting the customer value that it creates.

Let’s Discuss This

As the economy comes out of the recession and subsequent slow growth of the early 2000s, how might companies now use the better economic environment to raise prices? As a consumer, do you wait for sales to buy, or when you want something, do you go buy it whether it’s on sale or not?

2. What Is a Price?

a. In the narrowest sense, price is the amount of money charged for a product or service. More broadly, price is the sum of all the values that consumers exchange for the benefits of having or using the product or service.

b. Throughout most of history, prices were set by negotiation between buyers and sellers. Fixed price policies—setting one price for all buyers—is a relatively modern idea that arose with the development of large-scale retailing at the end of the nineteenth century.

c. The Internet, corporate networks, and wireless communications are con-necting sellers and buyers as never before, and we are seeing a return to dynamic pricing—charging different prices depending on individual customers and situations.

d. Pricing is the number one problem facing many marketing executives. But many companies do not handle pricing well. A frequent problem is that companies are too quick to reduce prices in order to get a sale rather than convincing buyers that their products are worth a higher price. Other common mistakes include pricing that is too cost-oriented and pricing that does not take the rest of the marketing mix into consideration.

Use Key Terms Price, Dynamic Pricing here.

Use Marketing at Work 9-1 here.

Use Under the Hood/Focus on Technology here.

3. Factors to Consider When Setting Prices

a. A company’s pricing decisions are affected by both internal company factors and external environmental factors.

Use Chapter Objectives 1 here.

Use Figure 9-1 here.

Use Discussing the Issues 1 here.

Internal Factors Affecting Pricing Decisions

b. The company must decide on its strategy for the product before setting its price. The marketing objectives include its target market and positioning; if this is set properly, then the marketing mix strategy, including price, is fairly straightforward. Pricing strategy is largely determined by decisions on market positioning.

1. There are other general or specific objectives.

i. General objectives include survival, current profit maximi-zation, market share leadership, and product quality leader-ship.

ii. More specifically, a company can set prices low to prevent competition from entering the market, or they can set prices at competitors’ levels to stabilize the market. Prices can be set to keep the loyalty and support of resellers. Prices can be reduced temporarily to create excitement for a new product.

c. The marketing mix strategy is very important. Price decisions must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective marketing program.

1. Companies often position their products on price and then tailor other marketing mix decisions to the prices they want to charge. Target costing reverses the usual process of first designing a new product, determining its cost, and then determining if they can sell it for that. Instead, it starts with an ideal selling price based on customer considerations, then targets costs that will ensure that the price is met.

Use Key Term Target Costing here.

2. Other companies de-emphasize price and use other marketing mix tools to create nonprice positions. Decisions about quality, promo-tion, and distribution will strongly affect price.

d. Costs set the floor for the price the company can charge. The company wants to charge a price that both covers all its costs for producing, distributing, and selling the product and delivers a fair rate of return for its effort and risk.

1. Fixed costs or overhead are costs that do not vary with production or sales level. Examples include rent, heat, and executive salaries.

2. Variable costs vary directly with the level of production. These costs tend to be the same for each unit produced.

3. Total costs are the sum of the fixed and variable costs for any given level of production.

Use Key Terms Fixed Costs, Variable Costs here.

e. There are also organizational considerations to setting prices. Companies handle pricing in a variety of ways.

1. In small companies, prices are often set by top management.

2. In large companies, pricing is typically handled by divisional or product line managers.

3. In industrial markets, salespeople may be allowed to negotiate with customers within certain price ranges.

4. In industries where pricing is a key factor, such as aerospace and steel, companies may have a pricing department to set the best prices or help others in setting them.

5. Others who may have an influence on pricing include sales managers, production managers, finance managers, and accoun-tants.

External Factors Affecting Pricing Decisions

f. Costs may set the lower limit of prices, but the market and demand set the upper limit of prices. All buyers balance the price of a product or service against the benefits of owning it. Before setting prices, marketers must understand the relationship between price and demand for their products.

g. Pricing freedom varies with the different types of markets. Economists recognize four types of markets.

1. Pure competition is a market that consists of many buyers and sellers trading in a uniform commodity such as wheat, copper, or financial securities.

i. No single buyer or seller has much effect on the going market price. Sellers in these markets do not spend much time on marketing strategy.

2. Under monopolistic competition, the market consists of many buyers and sellers who trade over a range of prices rather than a single market price.

i. A range of prices occurs because sellers can differentiate their offers to buyers. Either the physical product can be varied in quality, features, or style, or the accompanying services can be varied.

ii. Buyers see differences in sellers’ products and will pay different prices for them.

iii. Because there are many competitors in such markets, each firm is less affected by competitors’ pricing strategies than in oligopolistic markets.

3. In oligopolistic markets, there are a few sellers who are highly sensitive to each other’s pricing and marketing strategies.

i. The product can be uniform, as in steel, or nonuniform, as in cars and computers.

ii. There are few sellers because it is difficult for new sellers to enter the market.

4. In a pure monopoly, the market consists of one seller.

i. The seller may be a government monopoly (U.S. Postal Service), a private regulated monopoly (a power company), or a private nonregulated monopoly (DuPont when it introduced nylon).

ii. Pricing is handled differently in each case.

a. In a regulated monopoly, the government permits the company to set rates that will yield a “fair return,” one that will let the company maintain and expand its operations as needed.

b. Nonregulated monopolies are free to set prices at what the market will bear.

Applying the Concept

Name one company in each of a purely competitive market, in monopolistic competition, in an oligopolistic market, and in a pure monopoly. How do they differ in terms of products or services offered and how responsive they are to customers? How about in how they price their products and services?

h. The consumer will decide whether a product’s price is right. Pricing decisions must be buyer-oriented.

i. Companies find it difficult to measure the values customers will attach to its product. These values will vary both for different consumers and different situations.

j. Each price the company might charge will lead to a different level of demand. The relationship between the price charged and the resulting demand level is shown in the demand curve in Figure 9-2.

1. The demand curve shows the number of units the market will buy in a given time period at different prices that might be charged.

2. In normal cases, demand and price are inversely related; that is, the higher the price, the lower the demand.

3. In the case of prestige goods, the demand curve sometimes slopes upward. Consumers think that higher prices mean more quality. Still, if a company charges too high a price, the level of demand will be lower.

Use Key Term Demand Curve here.

Use Figure 9-2 here.

k. Most companies try to measure their demand curves by estimating demand at different prices. The type of market makes a difference.

1. In a monopoly, the demand curve shows the total market demand resulting from different prices.

2. If the company faces competition, its demand at different prices will depend on whether competitors’ prices stay constant or change with the company’s own prices.

l. Price elasticity is how responsive demand will be to a change in price. If demand hardly changes with a small change in price, demand is inelastic. If demand changes greatly, demand is elastic.

1. Buyers are less price sensitive when the product they are buying is unique or when it is high in quality, prestige, or exclusiveness. They are also less price sensitive when substitute products are hard to find or when they cannot easily compare the quality of sub-stitutes. Finally, they are less price sensitive when the total expen-diture for a product is low relative to their income or when the cost is shared by another party.

2. If demand is elastic rather than inelastic, sellers will consider lowering their price. A lower price will produce more total revenue. This practice makes sense as long as the extra costs of producing and selling more do not exceed the extra revenue.

Use Key Term Price Elasticity here.

m. Competitors’ costs and prices as well as possible competitor reactions to the company’s own pricing moves also affect pricing. The company’s pricing strategy may affect the nature of the competition it faces.

n. Economic conditions can have a strong impact on the firm’s pricing strategies. The company must also consider what impact its prices will have on other parties, such as resellers and the government. Social con-cerns should also be taken into account.

4. General Pricing Approaches

a. The price the company charges will be somewhere between one that is too low to produce a profit and one that is too high to produce any demand. Figure 9-3 summarizes the major considerations in setting price.

b. Companies set prices by selecting a general price approach.

Use Chapter Objectives 2 here.

Use Figure 9-3 here.

Cost-based Pricing

c. The simplest pricing method is cost-plus pricing—adding a standard markup to the cost of the product.

d. 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.

1. Sellers are more certain about costs than about demand. By tying price to cost, sellers simplify pricing.

2. When all firms in the industry use this pricing method, prices tend to be similar and price competition is minimized.

3. Many people feel that cost-plus pricing is fairer to both buyers and sellers.

e. Break-even pricing and target-profit pricing are other cost-oriented approaches. The firm tries to determine the price at which it will break even or make the target profit it is seeking.

1. Target pricing uses the concept of a break-even chart, which shows the total cost and total revenue expected at different sales volume levels. See Figure 9-4 for an example. Variable costs are added to fixed cost to form total costs, which rise with each unit sold. The slope of the total revenue curve reflects the price.

2. However, as the price increases, demand decreases, and the market may not buy even the lower volume needed to break even at the higher price. Much depends on the relationship between price and demand. Break-even analysis and target-profit pricing do not take this relationship into account.

Use Key Terms Cost-Plus Pricing, Breakeven Pricing (Target-Profit Pricing) here.

Use Figure 9-4 here.

Value-based Pricing

f. Value-based pricing uses 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 price. Price is considered along with the other marketing mix variables before the marketing program is set.

Use Key Term Value-based Pricing here.

Use Figure 9-5 here.

g. A comparison of cost-based pricing and value-based pricing is found in Figure 9-5. Cost-based pricing is product-driven. Value-based pricing reverses this process. The company sets its target price based on customer perceptions of the product value.

h. A company using value-based pricing must find out what value buyers assign to different competitive offers. Measuring this perceived value can be difficult. 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.

i. More and more, marketers have adopted value-pricing strategies—offering just 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.

1. An important type of 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.

i. In contrast, high-low pricing involves charging higher prices on an everyday basis but running frequent promotions to lower prices temporarily on selected items.

ii. Wal-Mart practically defined this concept. To offer everyday low prices, a company must first have everyday low costs.

Use Key Term Value Pricing here.

j. In many business-to-business situations, the challenge is to build the company’s pricing power—its power to escape price competition and to justify higher prices and margins without losing market share. To do this, many companies adopt value-added strategies. They attach value-added services to differentiate their offers and thus support higher margins.

k. Often, the best strategy is not to price below the competitor, but rather to price above and convince the customers that the product is worth it.

Use Speed Bump: Linking the Concepts here.

Let’s Discuss This

Has Wal-Mart’s “everyday low pricing” had much of an impact on other retailers? Why would Wal-Mart not want to do “high-low” pricing like most retailers? What advantages does Wal-Mart have over other discount stores in their EDLP strategy? What are the disadvantages they face?

Competition-based Pricing

l. One form of competition-based pricing is going-rate pricing, in which a 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 than, or less than its major competitors.

Use Key Term Competition-based Pricing here.

1. 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.

m. Competition-based pricing is also used when firms bid for jobs. Using sealed-bid pricing, a firm bases its price on how it thinks competitors will price, rather than on its own costs or on the demand.

n. Pricing decisions are subject to an incredibly complex array of environ-mental and competitive forces. A company sets not a single price, but rather a pricing structure that covers different items in its line. This pricing structure changes over time as products move through their life cycles. The company adjusts product prices to reflect changes in costs and demand and to account for variations in buyers and situations.

Use Discussing the Issues 2 here.

5. New-Product Pricing Strategies 

a. Pricing strategies usually change as the product passes through its life cycle. The introductory stage is especially challenging.

Market-Skimming Pricing

b. Many companies that invent new products set high prices to “skim” revenues layer by layer from the market. This is called market-skimming pricing.

1. Market skimming makes sense only under certain conditions. First, the product’s quality and image must support its higher price, and enough buyers must want the product at that price. Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price.

Use Key Term Market-Skimming Pricing here.

Use Chapter Objectives 3 here.

Market-Penetration Pricing

c. Market-penetration pricing sets an initial low price in order to penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing the company to cut is price even further.

1. The market must be highly price sensitive so that a low price produces more market growth. Production and distribution costs must fall as sales volume increases. The low price must help keep out competition, and the company that uses penetration pricing must maintain its low-price position.

Use Key Term Market-Penetration Pricing here.

Use Application Questions 1 here.

6. Product Mix Pricing Strategies 

a. The strategy for setting a product’s price often has to be changed when the product is part of a product mix. In this case, the firm looks for a set of prices that maximizes the profits on the total product mix. Pricing is difficult because the various products have related demand and costs and face different degrees of competition.

Product Line Pricing

b. Companies usually develop product lines rather than single products. In product line pricing, management must decide on the price steps to set between the various products in a line.

c. The price steps should take into account cost differences between the products in the line, customer evaluations of their different features, and competitors’ prices.

d. In many industries, sellers use well-established price points for the products in their line.

e. The seller’s task is to establish perceived quality differences that support the price differences.

Use Key Term Product Line Pricing here.

Use Chapter Objectives 4 here.

Use Application Questions 3 here.

Optional-Product Pricing

f. Optional-product pricing is offering to sell optional or accessory products along with the main product. For example, a car buyer may choose to order power windows, cruise control, and a CD changer.

g. Pricing these options is a sticky problem. Using the previous example, automobile companies have to decide which items to include in the base price and which to offer as options.

Use Key Term Optional-Product Pricing here.

Captive-Product Pricing

h. Companies that make products that must be used along with a main product are using captive-product pricing. Producers of the main products often price them low and set high markups on the supplies.

i. In the case of services, this strategy is called two-part pricing. The price of the service is broken into a fixed fee plus a variable usage cost. For example, theaters charge admission, then generate additional revenues from concessions. The service firm must decide how much to charge for the basic service and how much for the variable usage. The fixed amount should be low enough to induce usage of the service; profit can be made on the variable fees.

Use Key Term Captive-Product Pricing here.

By-product Pricing

j. In producing many commodities, such as processed meats and petroleum products, there are often by-products. Using by-product pricing, the manufacturer will seek a market for these by-products and should accept any price that covers more than the cost of storing and delivering them.

k. By-products can even turn out to be profitable.

Use Key Term By-product Pricing here.

Product Bundle Pricing

l. Sellers often combine several of their products and offer the bundle at a reduced price.

m. Price bundling can promote the sales of products consumers might not otherwise buy, but the combined price must be low enough to get them to buy the bundle.

Use Key Term Product Bundle Pricing here.

Use Application Questions 2 here.

7. Price-Adjustment Strategies

a. Companies usually adjust their basic prices to account for various customer differences and changing situations.

Use Chapter Objectives 5 here.

Discount and Allowance Pricing 

b. Most companies adjust their basic price to reward customers for certain responses, such as early payment of bills, volume purchases, and off-season buying.

1. The many forms of discounts include a cash discount, which is a price reduction to buyers who pay their bills promptly. A quantity discount is a price reduction to buyers who buy large volumes. A functional discount (also called a trade discount) is offered by the seller to trade-channel members who perform certain functions, such as selling, storing, and record keeping. A seasonal discount is a price reduction to buyers who buy merchandise or services out of season.

2. Allowances are another type of reduction from list price. Trade-in allowances are price reductions given for turning in an old item when buying a new one. Promotional allowances are payments or price reductions to reward dealers for participating in advertising and sales support programs.

Use Key Terms Discount, Allowance here.

Segmented Pricing

c. In segmented pricing, the company sells a product or service at two or more prices, even though the difference in prices is not based on differences in costs.

1. Under customer-segment pricing, different customers pay different prices for the same product or service.

2. Under product-form pricing, different versions of the product are priced differently, but not according to differences in their costs.

3. Using location pricing, a company charges different prices for different locations, even though the cost of offering each location is the same.

4. Using time pricing, a firm varies its price by the season, the month, the day, and even the hour.

d. Segmented pricing can be called revenue management or yield management.

e. For segmented pricing to be effective, the market must be segmentable, and the segments must show different degrees of demand. The costs of segmenting and watching the market cannot exceed the extra revenue from the price difference. The segmented price must be legal. And segmented prices should reflect real differences in customers’ perceived value.

Use Key Term Segmented Pricing here.

Applying the Concept

Why would a movie theater use segmented pricing? How is it applied? What kinds of companies use product-form pricing? Name some examples.

Psychological Pricing

f. In using psychological pricing, sellers consider the psychology of prices and not simply the economics. Consumers usually perceive higher-priced products as having higher quality; when they cannot judge quality because they lack the information or skill, price becomes an important quality signal.

g. Reference prices are prices that buyers carry in their minds and refer to when looking at a given product. The reference price might be formed by noting current prices, remembering past prices, or assessing the buying situation.

Use Key Terms Psychological Pricing, Reference Prices here.

Promotional Pricing

h. With promotional pricing, companies will temporarily price their products below list price and sometimes even below cost to create buying excitement and urgency.

i. Supermarkets and department stores will price a few products as loss leaders to attract customers to the store in the hope that they will buy other items at normal markups.

j. Sellers will also use special-event pricing in certain seasons to draw more customers.

k. Manufacturers sometimes offer cash rebates to consumers who buy a product from dealers within a specified time; the manufacturer sends the rebate directly to the customer.

l. Some manufacturers offer low-interest financing, longer warranties, or free maintenance to reduce the customer’s “price.” Or the seller may simply offer discounts from normal prices to increase sales and reduce inventories.

m. Promotional pricing can have adverse effects. Used too frequently and copied by competitors, price promotions can create “deal-prone” cus-tomers who wait until brands go on sale before buying them. Or, constantly reduced prices can erode a brand’s value in the eyes of customers. The frequent use of promotional pricing can also lead to industry price wars.

Use Key Term Promotional Pricing here.

Use Marketing at Work 9-2 here.

Use Speed Bump: Linking the Concepts here.

Use Discussing the Issues 3 here.

Geographical Pricing

n. A company also must decide how to price its products for customers located in different parts of the country.

o. FOB-origin pricing means that goods are placed free on board a carrier. At that point the title and responsibility pass to the customer, who pays the freight from the factory to the destination.

p. Uniform-delivered pricing is the opposite of FOB pricing. Here, the company charges the same price plus freight to all customers, regardless of their locations. The freight charge is set at the average freight cost. This is fairly easy to administer, and it lets the firm advertise its price nationally.

q. Zone pricing falls between FOB-origin pricing and uniform-delivered pricing. The company sets up two or more zones. All customers within a given zone pay a single total price; the more distant the zone, the higher the price.

r. Basing-point pricing is when the seller selects a given city as a “basing point” and charges all customers the freight cost from that city to the customer location, regardless of the city from which the goods are actually sent. Some companies set up multiple basing points to create more flexibility; they quote freight charges from the basing-point city nearest to the customer.

s. Finally, the seller who is anxious to do business with a certain customer or geographical area might use freight-absorption pricing. Using this strategy, the seller absorbs all or part of the actual freight charges in order to get the desired business.

Use Key Term Zone Pricing here.

Use Discussing the Issues 5 here.

International Pricing

t. Companies that market their products internationally must decide what prices to charge in the different countries in which they operate. In some case, a company can set a uniform worldwide price. Most companies adjust their prices to reflect local market conditions and cost considerations.

u. The price that a company should charge in a specific country depends on many factors, including economic conditions, competitive situations, laws and regulations, and development of the wholesaling and retailing systems. Consumer perceptions and preferences also may vary from country to country, calling for different prices. Or the company may have different marketing objectives in various world markets, which require changes in pricing strategy.

v. Costs play an important role in setting international prices. In some cases, price escalation may result from differences in selling strategies or market conditions. In most instances, it is simply a result of the higher costs of selling in another country—the additional costs of product modifications, shipping and insurance, import tariffs and taxes, exchange-rate fluctuations, and physical distribution.

w. More detail on international pricing is presented in Chapter 15.

8. Price Changes

a. After developing their pricing structures and strategies, companies often face situations in which they must initiate price changes or respond to price changes by competitors.

Use Chapter Objectives 6 here.

Initiating Price Changes

b. Several situations may lead a firm to consider cutting its price. One reason is excess capacity. In this case, the firm needs more business and cannot get it through increased sales effort, product improvement, or other measures.

c. Another situation leading to price changes is falling market share in the face of strong price competition. A company may also cut prices in a drive to dominate the market through lower costs. Either the company starts with lower costs than its competitors, or it cuts prices in the hope of gaining market share that will further cut costs through larger volume.

d. A successful price increase can greatly increase profits. A major factor in price increases is cost inflation. Rising costs squeeze profit margins and lead companies to pass cost increases along to customers.

e. Another factor leading to price increases is overdemand; when a company cannot supply all that its customers need, it can raise its prices, ration products to customers, or both.

f. Prices can be raised almost invisibly by dropping discounts and adding higher-priced units to the line. 

g. In passing price increases on to customers, the company must avoid being perceived as a price gouger. There are some techniques for avoiding this problem. One is to maintain a sense of fairness surrounding any price increase. Price increases should be supported by company communi-cations telling customers why prices are being increased.

h. Making low-visibility price moves first is a good technique—eliminating discounts, increasing minimum order sizes, and curtailing production of low-margin products.

i. A company should try to meet higher costs of demand without raising prices. It can consider more cost-effective ways to produce or distribute its products. It can shrink the product instead of raising the price. It can substitute less expensive ingredients or remove certain product features, packaging, or services. Or it can “unbundle” its products and services, removing and separately pricing elements that were formerly part of the offer.

j. Whether the price is raised or lowered, the action will affect buyers, competitors, distributors, and suppliers, and may interest the government as well.

1. Customers do not always interpret prices in a straightforward way. They may view a price cut in several ways. They might believe that quality was reduced. Or they might think that the price will come down even further and that it will pay to wait and see.

2. A price increase may have some positive meanings for buyers. Customers might think that the item is very “hot” and may be unobtainable unless they buy it soon. Or they might think that the item is an unusually good value.

3. Competitors are most likely to react to a price change when the number of firms involved is small, when the product is uniform, and when the buyers are well informed.

4. Like with a consumer, a competitor can interpret price changes in many ways. So the company must guess each competitor’s likely reaction.

Responding to Price Changes

k. In responding to competitors’ price changes, the company needs to consider several issues: Why did the competitor change the price? Was it to take more market share, to sue excess capacity, to meet changing cost conditions, or to lead an industry-wide price change? Is the price change temporary or permanent? What will happen to the company’s market share and profits if it does not respond? Are other companies going to respond?

l. A broader analysis must also be done. The company has to consider its own product’s stage in the life cycle, the product’s importance in the company’s product mix, the intentions and resources of the competitor, and the possible consumer reactions to price changes.

m. Planning ahead for price changes cuts down reaction time. Figure 9-6 shows the ways a company might assess and respond to a competitor’s price cut.

1. It could reduce its price to match the competitor’s price. It may decide the market is price sensitive and that it would lose too much market share to the lower-price competitor.

2. The company could maintain its price but raise the perceived value of its offer. It could improve communications, stressing the relative quality of its product over that of the lower-price competitor.

3. The company might improve quality and increase price, moving its brand into a higher-price position.

4. The company might launch a low-price “fighting brand” by adding a lower-price item to the line or creating a separate lower-price brand. This is necessary if the particular market segment being lost is price sensitive and will not respond to arguments of higher quality.

Use Figure 9-6 here.

Use Discussing the Issues 4 here.

9. Public Policy and Pricing

a. Price competition is a core element of our free-market economy. In setting prices, companies are not usually free to charge whatever prices they wish. Many federal, state, and even local laws govern the rules of fair play in pricing. The most important pieces of legislation affecting pricing are the Sherman, Clayton, and Robinson-Patman acts, initially adopted to curb the formation of monopolies and to regulate business practices that might unfairly restrain trade.

b. Figure 9-7 shows the major public policy issues in pricing. These include price-fixing and predatory pricing as well as retail price maintenance, discriminatory pricing, and deceptive pricing.

Use Marketing at Work 9-3 here.

Use Figure 9-7 here.

Pricing Within Channel Levels

c. Federal legislation on price-fixing states that sellers must set prices without talking to competitors. Otherwise, price collusion is suspected.

d. Sellers are also prohibited from using predatory pricing—selling below cost with the intention of punishing a competitor or gaining higher long-run profits by putting competitors out of business. This protects small sellers from larger ones who might sell items below cost temporarily or in a specific locale to drive them out of business.

Pricing Across Channel Levels

e. The Robinson-Patman Act seeks to prevent unfair price discrimination by ensuring that sellers offer the same price terms to customers at a given level of trade. Every retailer is entitled to the same price terms from a given manufacturer. However, price discrimination is allowed if the seller can prove that its costs are different when selling to different retailers. Or the seller can discriminate in its pricing if the seller manufactures different qualities of the same product for different retailers.

f. Retail price maintenance is also prohibited—a manufacturer cannot require dealers to charge a specified retail price for its products. Although the seller can propose a manufacturer’s suggested retail price to dealers, it cannot refuse to sell to a dealer who takes independent pricing action, nor can it punish a dealer by shipping late or denying advertising allowances.

g. Deceptive pricing occurs when a seller states prices or price savings that mislead consumers or are not actually available to consumers. This might involve bogus reference or comparison prices, as when a retailer sets artificially high “regular” prices then announces “sale” prices close to its previous everyday prices.

1. Scanner fraud is another means of deceptive pricing. The widespread use of scanner-based computer checkouts has led to increasing complaints of retailers overcharging their customers.

2. Price confusion results when firms employ pricing methods that make it difficult for consumers to understand just what price they are really paying. For example, consumers are sometimes misled regarding the real price of a home mortgage or car leasing agreement.

Use Focus on Ethics here.

Travel Log

Discussing the Issues

1. Imagine that you are setting flight prices for Southwest Airlines. How would the internal and external factors identified in Figure 9-1 impact your pricing decision?

Several of the factors listed in Figure 9-1 will likely have an impact on Southwest’s pricing decision. For example, the marketing objective of being the low cost airline will lead to prices being set at or below competitors’ levels. The airline’s costs will set the floor for its pricing levels, while market demand will set the upper limits. The current economic conditions and the number of passengers traveling are also factors that Southwest will take into account. Airlines are an interesting industry from a pricing standpoint because they change their price so often to account for fluctuations in demand and competitors’ actions.

2. Explain the differences between cost-based pricing, value-based pricing, and competition-based pricing. Under what conditions might a company favor one approach over the others?

Cost-based pricing focuses on the company’s costs as an integral part of the pricing decision. As such, it is product-driven. For example, const-plus pricing is a cost-based method that adds a standard markup (often a percentage) to the cost of the product. Value-based pricing uses buyers’ perceptions of value to set price. In value based pricing, price is considered along with the other marketing mix variables before the marketing program is set. Competition-based pricing places a great deal of emphasis on the price of other firms’ competitive products. One form of competition-based pricing is going-rate pricing, in which a firm bases its price largely on competitors’ prices, with less attention paid to its own costs or to demand. 

3. Given that higher-priced products are often perceived as being higher in quality, what implications does a low price have for marketers using promotional pricing strategies? 

Low prices bring with them the concern that consumers may perceive the product as being of low quality, rather than being a great value. One way to combat this is to have a high base price and then represent the discounted price as a markdown from the higher base price. In this way, consumers are able to use the high base price as a reference in their quality assessments.

4. Your major competitor has just cut its prices by 20% on all products. How should you react? What information do you want to have before you craft a response?

The company has several response options (not all of which entail lowering its own price), but should first consider several issues: Why did the competitor change the price? Was it to take more market share, to use excess capacity, to meet changing cost conditions, or to lead an industry-wide price change? Is the price change temporary or permanent? What will happen to the company’s market share and profits if it does not respond? Are other companies going to respond? And what are the competitor’s and other firms’ responses to each possible reaction likely to be? It also has to consider its own product’s stage in the life cycle, the product’s importance in the company’s product mix, the intentions and resources of the competitor, and the possible consumer reactions to price changes.

5. Review the geographical pricing strategies of FOB-origin pricing, uniform-delivered pricing, zone pricing, basing-point pricing, and freight absorption pricing. What factors influence the choice of a geographical pricing strategy?

Companies should consider how its competitors handle shipping costs, how much time it has to spend on administering different pricing options for shipping, and the price sensitivity of the customer.

Application Questions

1. Your company is about to launch a new brand of paper towels on the market that are more absorbent and durable than current paper towels being sold. Your boss wants you to consider both market-skimming pricing and market-penetration pricing strategies. What factors should you consider in making your decision?

Market skimming makes sense only under certain conditions. First, the product’s quality and image must support its higher price, and enough buyers must want the product at that price. Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price. For market-penetration pricing the following conditions should be considered: First, the market must be highly price sensitive. Second, production and distribution costs must fall as sales volume increases. Finally, the low price must help keep out the competition.

2. Select an athletic team, theater series, or other event at your school where tickets can be purchased individually or in a bundle (i.e., season tickets). Get pricing information for both single event/game and bundled tickets. Is the cost on a per- ticket basis less expensive for the bundled price? Does the price difference entice you to buy the bundle instead of individual tickets? Aside from maximizing revenue, what else might an event marketer be concerned with in deciding how to set ticket prices?

Responses to this question will vary according to the particular event selected by the student. An event marketer may also be interested in filling the theater or stadium. No one wants to go to a football game and be the only one there! As such, some may charge a lower price knowing that the event will be filled, rather than have a large number of empty seats.

3. Visit a department store and find brands in three different product categories (e.g., televisions, refrigerators, tennis racquets) that engage in product line pricing. Do you feel that the price-to-attribute/feature trade-off in the product line is appro-priate? Pick the product in each line that offers the most value to you. Describe a market segment that would have selected a different product as having the most value. What market segment is each product trying to reach with its offerings?

Responses will vary depending on the products selected and student opinion. Instructors can use this question to highlight the notion of product line pricing. This question can be extended by asking students to consider if they feel price changes are needed based on competitive products or to differentiate the company’s own brands further.

Under the Hood/Focus on Technology

The ability to quickly compare prices over the Internet has been a boon to consumers and either a blessing or curse to retailers (depending which side of the “pricing fence” you are on). Websites such as Streetprices.com, Nextag.com, and PriceScan.com allow consu-mers to quickly comparison shop for specific products at dozens of retailers. Imagine how long that would take if you were trying to drive all over town to accomplish the same thing! Some will even email you when the product you are interested in reaches or falls below your target price.

Go to one of the websites listed above and do a comparison for a television and a vacuum cleaner. Then respond to the following questions.

1. What do you think of this service? Do you trust the retailers offering the lowest prices? What concerns might a consumer have when using one of these websites to select a seller?

Student responses to this question will vary. Concerns that may be brought up by the instructor if not discussed by the students include issues of not being able to “touch” the merchandise, delivery times, dealing with product returns, revealing credit card information, and the inability to ask the seller questions prior to a purchase. These concerns apply to most Internet buys.

2. How can a local “brick and mortar” store in your town compete with the com-panies offering products through such websites?

Price advantages will often go to the Internet sites. Local firms may need to emphasize other aspects to make the consumer feel the added price is the better overall value. For example, a brick and mortar store may offer additional service at the point of sale and after the purchase is made. 

3. What other features of these websites make them attractive for buyers?

Students will often come up with responses such as the convenience to access product and price information from home, the ability to quickly look at multiple sellers of the same product in a side-by-side comparison, and the direct links to the sellers’ websites.

Focus on Ethics

In order to promote competition, federal laws prohibit price-fixing—competitors agreeing on what levels to set prices. Some companies find themselves in the media spotlight after being accused of price-fixing. In recent years, rival auction houses Christie’s and Sotheby’s have been found guilty of fixing the commission rates they earned from auctions. More recently, some of the top modeling agencies have come under investi-gation for conspiring to fix the commissions they charge models to book their assign-ments. Being found guilty of price-fixing in the United States can bring jail time and large fines.

1. Why is price-fixing dealt with so harshly in the United States? Why shouldn’t companies be able to discuss price levels and set whatever price they agree on?

Most students will understand that the purpose behind the laws is to promote a competitive market that offers the best price/value combination to the consumer. Allowing collusion between businesses will harm the consumer.

2. What might a company do to discourage employees from engaging in price-fixing? What factors might encourage companies to collude on prices?

Education can be a large part of efforts to stop price-fixing by employees. By making it clear what the laws and consequences of breaking those laws are, employees will better understand appropriate and inappropriate behaviors.

3. Does the rapid availability of competitive price information on the Internet help to facilitate price-fixing?

This is an interesting question, because on the one hand competitors have better access to each other’s prices, which would allow price-fixing to take place. However, on the other hand, access to the information also exposes price-fixing information or at least makes it more visible to regulators and the public.

GREAT IDEAS

Barriers to Effective Learning

1. Even if a student or two has worked in a family business, it is a very safe bet that none of them have ever set prices on anything. Even if they are a devotee of eBay and have been buying and selling items for years, they still won’t have set prices because of the auction environment of that and other sites that have sprung up in the years since the explosion of the World Wide Web. So although the “What Is a Price?” section is very short, it is well worthwhile spending some time talking about the difference between fixed-price policies and dynamic pricing. A discussion of what it’s like to buy a meal at a restaurant, where you cannot typically haggle on price, and buying a car, where you are expected to haggle on price, can drive home the difference between the two. A discussion of what has happened with auctions and exchanges online will also help. Using Marketing at Work 9-1 here to launch the discussion would be useful.

2. There are so many factors to consider in setting prices that the students might begin to feel overwhelmed very early in the chapter. It might be easier to discuss this in the context of a new business the class will launch—say, a laundry service on campus. Most students hate doing laundry, so they are willing to pay for someone to do it for them, especially with pickup and delivery service. You can easily run through the internal and external factors that would affect such a service, and even discuss pricing strategy if a competitor were to develop a similar service.

3. Students will also likely not understand why cost-based pricing isn’t the right way to price everything. It’s simple, it’s easy to apply a formula, and there is no guesswork involved. You need to drive home the point that it ignores the custo-mer completely—cost-based pricing is internally focused, without a thought to the demand parameters or competitors’ prices. You can talk about this from the perspective of a high-cost manufacturer; how much would they be able to sell if their product cost 50% more than the competition simply because the company hadn’t figured out how to manufacture it effectively?

4. Value-based pricing could engender a considerable amount of conversation, particularly if someone thinks it is unethical to charge a price for something that yields the company a very large margin. Why wouldn’t you treat customers “right” by charging them less? A discussion of the meaning of customer focus and of benefits to the customer will help the class to understand that if the customer thinks he is getting value, he will happily pay the price.

5. After this discussion, the students might then be quite confused that value pricing and everyday low pricing are subsets of value-based pricing. It might be helpful here to differentiate between value-based pricing in a business market and value or EDLP in the consumer market. Many businesses will buy based on a value they assign to a product or service, often in terms of ROI for themselves. Consumers will rarely do that explicitly and, at least for basic necessities, will often buy based on price. It is still value-based pricing.

6. Product line pricing can easily be illustrated with the example of gasoline. Virtually every gas station in this country sets the prices of each of its grades of gas between 8 and 10 cents apart (e.g., regular for $1.43, the next grade for $1.53, and the premium grade for $1.63). This is an everyday example of price steps with which everyone will have experience. Captive-product pricing will also be a fairly easy concept to understand with the example of razors and razor blades. Optional-product pricing could cause some problems, however. Discussing the example of buying a computer with or without a service agreement could help explain how this is done.

7. Segmented pricing can easily be explained with senior citizen discounts or the discount you get at the movies for going during the day (matinee prices). Most students today have traveled, so it is also useful to talk about the airlines’ use of yield management.

8. Geographical pricing can cause some problems. Although the students might have heard of FOB pricing, it will not be a common term for them. Explaining that this is basically a decision between the customer paying the freight and the company paying the freight will help, especially because the majority of the students will have purchased at least something online, so they will have experience with freight or delivery charges.

9. Discussing the meaning students have applied to price changes on the goods they buy is an interesting way of introducing this section. You may need to force the students to really think through why, for instance, so many retailers seem to run constant sales, and what that says about their merchandise and their business. This would also be a good time to swing back to the new business launched in Barrier #2 (above) to have the students discuss how they would react price-wise to new competitors. Would they start a price war, feeling certain that their customers would stick around, so that they could then drive the price back up when the competitor “leaves town”?

Student Projects

1. Explain the concept of elasticity of demand. Identify several factors that influence elasticity and give examples as to how they affect the degree of elasticity in a product or service.

2. When does a price become a promotional price? What pitfalls does a firm risk in promotional pricing?

3. How does price relate to consumer perceptions of quality? Give examples of your perception of an acceptable price range for toothpaste, a haircut, and a dinner at a fancy restaurant. How might price outside this range affect your image of the product’s quality?

4. Find examples of products that seem to fit the following marketing objectives for pricing and explain your reasons for picking the products: survival, current profit maximization, market share leadership, and product quality leadership.

5. Are optional-product pricing and captive-product pricing ethical? Are these policies sound? Why or why not?

Classroom Exercise/Homework Assignment 

Airlines are well known for their yield management practices. Assume that your next Spring Break trip is to Cancun, Mexico. Go online to “book” your trip and compare airfares among the major airlines that fly to that destination, as well as the major travel websites. Some of the airline websites include U.S. Air (www.usair.com), Delta Airlines (www.delta.com), Continental Airlines (www.continental.com), and United Airlines (www.united.com). Also look at the online travel agencies including Orbitz (www.orbitz.com) and Expedia (www.expedia.com). Another possibility is Cheap Fares, an industry consolidator (www.cheapfares.com).

1. First check fares through the individual airlines’ sites, and then go to the two online travel agency sites to check fares for the same dates and times. Do they differ, or are they the same? Why might they differ?

Student responses will differ, but by and large the fares should be different not only among the different airlines, but also between the individual airlines and the travel consolidator. This is due to the airlines’ yield management systems as well as their explicit decision to offer the lowest fares on their own websites.

2. Go back the next day and the next week to check the fares for the exact same dates and times. Are the fares different yet? Why might that be?

Fares may have gone either up or down, depending on demand at the time. Students should discuss this in terms of why demand shifts as you get closer to the date of takeoff, as well as elasticity of demand.

3. Read through the business press, searching such sites as www.cnnmoney.com and www.wsj.com (CNN Money and the Wall Street Journal) to see if there has been any recent news about any of these airlines. What internal and external factors might be affecting the setting of the airfares at this particular moment in time?

Responses will vary based on what is in the recent news. However, the bankruptcy proceedings of the major airlines in Chapter 11 should figure prominently in their answers.

Classroom Management Strategies

This is a very long chapter, and it might be best to break it into two class periods. It will be noted in the following where a reasonable break would be if you are able to do that.

1. Discussing the history of pricing, and the differences between fixed prices and dynamic prices is worthy of at least 5 minutes. You can also tie dynamic pricing back into the individual markets that were discussed in a previous chapter to drive home the value of dynamic pricing.

2. If you are breaking the chapter into two class sessions, spend 20 minutes on Factors to Consider when Setting Prices. If you do not have that luxury, 10 minutes will suffice. But in this case, you will want to hit the major factors of marketing objectives and marketing mix strategy for internal factors, and the market and demand for the external factors. 

3. Another 20 minutes should be spent on General Pricing Approaches in a two-session approach to this chapter. If covering the material in one session, spend 10 minutes on this. In this approach, focus on the differences among the three pricing approaches.

4. New Product Pricing Strategies should be covered in 15 minutes. In one class session, spend about 5 minutes covering the differences between market skimming and market penetration. This would also be where you should break for the session if you are going to continue with the chapter in the next class.

5. Product Mix Pricing Strategies has a lot of information in it. In the second class session, spend 20 minutes on this topic, being sure to cover each of the five subsections. In one class period, you can cover this in 10 minutes by focusing on the three pricing strategies, briefly explaining the last two.

6. Price-Adjustment Strategies also has a lot of material in it. In a second class section, 20 minutes should also be spent on this topic. In one, again you can cover this in 10 minutes by focusing on the first three subsections.

7. Regardless of whether you are presenting this material in one class or two, spend 15 minutes on Price Changes. This is an important element to understanding pricing, and this is the area where many marketing managers make their money when it comes to pricing.

8. Public Policy and Pricing can be covered in 5 minutes. The important topics in this section are the problems that can occur in and the ethical issues around setting prices.

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