developing pricing strategy

Developing Pricing Strategies and

Programs

Price is the sum of all values that consumers exchange for the

benefits of having or using the product or service. Price is the only element in the marketing mix that produces revenue;

What is Price?

the others produce cost.

Price has many names:

• Rent

• Tuition

• Fare

• Rate

• Commission

• Wage

• Fee

• Dues

• Interest

• Donation

• Salary

Common Pricing Mistakes

• Companies base their prices on their costs, not their customers’ perceptions of value.

• Companies base their prices on “the marketplace” taking traditional industry margins

• Failure to vary price by product item, market segment, distribution channels, and purchase occasion attempting to achieve the same profit margin across different product lines.

• Companies hold prices at the same level for too long, ignoring changes in costs, market, competitive environment and in customers’ preferences.

• Setting price independently of the rest of the marketing mix

Steps in Setting Pricing

Setting the Price

Pricing Steps

1. Select pricing objective

2. Determine demand3. Estimate costs4. Analyze competition5. Select pricing method6. Select final price

• Survival• Maximize current profits• Maximize market share

– Penetration strategy• Market skimming

– Skimming strategy• Product quality leaders• Partial cost recovery

Pricing Objectives:

• Survival. Companies pursue survival as their major objective if they are plagued with overcapacity, intense competition, or changing consumer wants. As long as prices cover variable costs and some fixed costs, the company stays in business.

• Maximum Current Profit. Many companies try to set a price that will maximize current profits. They estimate the demand and costs associated with alternative prices and choose the price that produces maximum current profit, cash flow, or rate of return on investment.

• Maximum Market Share/Market-penetration Pricing. Some companies want to maximize their market share. They believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest price, assuming the market is price sensitive.

• Market Skimming. Companies unveiling a new technology favor setting high prices to maximize market skimming,i.e. prices start high and slowly drop over time.

Pricing Objectives:

• Product-Quality Leadership. A company might aim to be the product-quality leader in the market. Products or services characterized by high levels of perceived quality, taste, and status are priced just high enough not to be out of consumers’ reach.

• Partial Cost Recovery. Nonprofit and public organizations may have other pricing objectives such as partial cost recovery knowing that it must rely on private gifts and public grants to cover its remaining costs.

Setting the Price

Pricing Steps

1. Select pricing objective2. Determine demand3. Estimate costs4. Analyze competition5. Select pricing method6. Select final price

• Understand factors that affect price sensitivity

Consumers are less price sensitive when:

• Product is more distinctive• Buyers are less aware of

substitutes• Buyers cannot easily

compare quality of substitutes

• The expenditure is a lower part of buyer’s total income

• The expenditure is small compared to the total cost

• Part of the cost is borne by another party

• The product is used with assets previously bought

• The product is assumed to have more quality, prestige, or exclusiveness

• Buyers cannot store the product

Setting the Price

Pricing Steps

• Understand factors that affect price sensitivity

• Estimate demand curves:Statistical analysisPrice experimentsSurveys

• Understand price elasticity of demand:Elasticity Inelasticity

Inelastic & Elastic Demand

Demand is less elastic when:

• There are few or no substitutes/competitors

• Buyers do not readily notice the higher price

• Buyers are slow to change their buying habits and search

for lower prices

• Buyers think higher prices are justified

Setting the Price

Pricing Steps

• Types of costs and levels of production must be considered

Setting the Price

Major Types of Costs:

Fixed costs/overhead: costs that don’t vary with

production or sales revenue.

Variable costs: vary with the level of production.

Total costs: sum of fixed and variable costs at a given

level of production

Average cost: cost per unit at a given level of

production = total cost/quantity of production.

Setting the Price

Pricing Steps

• Types of costs and levels of production must be considered

• Accumulated production leads to cost reduction via the experience curve

• Differentiated marketing offers create different cost levels (Activity-based cost ABC)

Cost per Unit as a Function of Accumulated Production: The Experience Curve

As production accumulates average cost decreases

Setting the Price

Pricing Steps

• Firms must analyze the competition with respect to:CostsPricesPossible price

reactions• Pricing decisions are also

influenced by quality of offering relative to competition

Setting the Price

Pricing Steps

• Price-setting begins with the three “Cs”

The Three C’s Model for Price Setting

Costs Competitors’prices and

prices of

substitutes

Customers’assessment

of unique

product

features

Low Price

No possible

profit at

this price

High Price

No possible

demand at

this price

Setting the Price

Pricing Steps

• Price-setting begins with the three “Cs”

• Select pricing method:– Markup pricing– Target-return pricing– Perceived-value

pricing– Value pricing– Going-rate pricing– Auction-type pricing

Pricing Methods:

1. Markup Pricing. Markup Pricing is just adding a standard mark-up to

the product’s cost.

• Variable cost per unit $10.00• Fixed Cost $ 300,000.00• Expected Unit Sales 50,000 units• Unit cost = variable cost + fixed cost = $10.00 + $ 300,000.00 = $16.00 50,000• Desired Mark Up= 20%• Selling Price= Unit Cost = $16.00 = $20

(1- desired return) (1-0.20)

• It will make profit of 4$ per unit

Pricing Methods:

Target-return price = unit cost + desired return x invested capital

Unit sales

2. Target-Return Pricing. pricing used to achieve a planned

or target rate of return on investment.

Target-return price = 16$ + 0.20 x 1,000,000

$50,000

= $20.00

Break-Even Chart for Determining Target-Return Price and Break-Even Volume

Pricing Methods:

3. Perceived-Value Pricing

• Companies base their price on the customer’s perceived value.

• The key to perceived-value pricing is to deliver more value than

the competitor and to demonstrate this to prospective buyers.

Perceived Value Pricing Example:

• $ 90,000 tractor’s price = competitor’s price

• $ 7,000 superior durability

• $ 6,000 superior reliability

• $ 5,000 superior service

• $ 2,000 longer warranty

• $ 110,000 superior value

• - 10,000 discount

• $ 100,000 final price

Pricing Methods:

4. Value Pricing. Win loyal customer by charging a fairly low

price for a high-quality offering, that means : reengineering

the companies operations to be low-cost without sacrificing

quality.

5. Going-Rate Pricing. The firm bases its price largely on

competitors’ prices. (smaller firms “follow the leader”).It is

quite popular where costs are difficult to measure or

competitive response is uncertain.

Pricing Methods:

6. Auction-Type Pricing. One major purpose of auctions is to

dispose of excess inventories or used goods. Three major

types of auctions:

1- English auctions (ascending bids).

2- Dutch auctions (descending bids).

3- Sealed-bid auctions.

Setting the Price

Pricing Steps

• Requires consideration of additional factors:– Impact of other

marketing activities– Company pricing

policies– Gain and risk sharing

pricing– Impact of price on other

parties

Final Price-Additional Considerations:

• Impact of Other Marketing Activities .The final price must take into account the brand’s quality and advertising relative to the competition.

• Company Pricing Policies. The price must be consistent with company pricing policies in order to ensure that salespeople quote prices that are reasonable to customers and profitable to the company.

• Gain and Risk Sharing Pricing. In case buyers resist accepting a seller’s proposal because of a high perceived level of risk,the seller has the option of offering to absorb part or all the risk if it does not deliver the full promised value.

• Impact of Price on Other Parties. Considering the impact of contemplated price on other parties such as:– distributors - sales force – suppliers - competitors – dealers /retailers

Adapting the Price

1. Geographical Pricing Barter: the direct exchange of goods with no money and no third party

involved Compensation deal: the seller receives some percentage of the

payment in cash and the rest in products Buyback arrangement: the seller sells a plant equipment or

technology to another country and agrees to accept as partial payment products manufactured with the supplied equipment

Offset: the seller receives full payment in cash but agrees to spend a substantial amount of the money in that country within a stated time period.

Adapting the Price

1. Geographical Pricing Barter: the direct exchange of goods with no money and no third party

involved Compensation deal: the seller receives some percentage of the

payment in cash and the rest in products Buyback arrangement: the seller sells a plant equipment or

technology to another country and agrees to accept as partial payment products manufactured with the supplied equipment

Offset: the seller receives full payment in cash but agrees to spend a substantial amount of the money in that country within a stated time period.

Adapting the Price

2. Price Discounts and Allowances•Quantity discount. The more you buy, the cheaper it becomes-- cumulative and non-cumulative.•Functional/Trade discounts. Discount offered by a manufacturer to trade-channel members if they will perform certain functions•Cash discount. A deduction granted to buyers for paying their bills within a specified period of time, (after first deducting trade and quantity discounts from the base price).•Seasonal discount. A price reduction to those who buy out of season.•Allowance. An extra payment designed to gain reseller participation in special programs.

Adapting the Price

3. Promotional Pricing• Loss-leader pricing: supermarkets and department stores often

drop the price on well known brands to stimulate additional store traffic

• Special-event pricing: sellers well establish special pricing in certain seasons to draw in more customers

• Cash rebates: companies offer cash rebates to encourage purchase of the manufacturers products within a specified time period

• Low-interest financing: the company can offer customers low-interest financing

• Longer payment terms : sellers especially mortgage banks and auto companies stretch loans over longer periods and thus lower the monthly payment

Adapting the Price

• Warranties and service contracts: companies can promote sales by adding a free or low cost warranty or service contract

• Psychological discounting: this strategy involves setting an artificially high price and then offering the product at substantial savings

Adapting the Price

4. Differentiated/Discriminatory Pricing. Companies often adjust their basic price to accommodate differences in customers, products, locations, etc. Discriminatory pricing tactics include:

– Customer-segment pricing. Different customer groups pay different prices for the same product or service.

– Product-form pricing. Different versions of the product are priced differently, but not proportionately to their costs.

– Image pricing. Some companies price the same product at two different levels based on image differences

Adapting the Price

– Channel pricing. Coca-Cola carries a different price depending on whether the consumer

purchases it in a fine restaurant, a fast-food restaurant, or a vending machine.

– Location pricing. The same product is priced differently at different locations though the

cost at each location is the same

– Time pricing. Prices are varied by season, day, or hour. Energy rates to commercial users

vary accordingly.

Initiating and Responding to Price Changes

Key Considerations

1. Initiating price cuts2. Initiating price

increases3. Responding to

competitor’s price changes

• Circumstances leading to price cuts:– Excess plant capacity– Declining market share– Attempt to dominate the

market via lower costs• Price cutting traps:

– Price/quality perceptions– Low prices don’t create

market loyalty– Competition may match or

beat price cuts

Key Considerations

• Circumstances leading to price increases:– Cost inflation– Over demand

Key Considerations

• The degree of product homogeneity affects how firms respond to price cuts initiated by the competition

• Market leaders can respond to aggressive price cutting by smaller competitors in several ways

• Maintain price and profit margin (vulnerable)

• Maintain price and add value

• Reduce price (and cost)

• Increase price and improve quality (add new brand)

• Launch a low-price product line

Market Leader can respond to competitor initiated price

cuts in several ways:

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developing pricing strategy

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