Marketing Management MKT 600

MM BB AA

Price in Mktg Mngnt & pricing strategy

2

Pricing Decisions

Lecture Overview

Introduction Theory of Pricing Pricing Objectives Strategic Determinants of Price

CostsDemandCompetition

Positioning of Life Cycles Pricing Strategies

Market skimmingMarket penetrationDestroyer pricing Promotional pricing

3

INTRODUCTION

All products and services have a price just as they have value. Many non-profit and all

profit-making organisations must also set prices, be they; the price to see a consultant

doctor or to buy a pair of trainers or a price to visit the island where Princess Diana lies.

Pricing is a measure of what a product is worth in that it sets a value for a product and

service – but it also goes under many names. For example, Rent for your flat Tuition for your education Fee to see your dentist Airline, bus and taxi firms charge a fare A guest lecturer charges an honorarium Clubs and societies charge subscriptions Lawyers may ask for a retainer

Definition - ‘Price is the sum of all the values that consumers exchange for the benefits of having or using the product and service.’

4

Probably the single most important decision in marketing is price, in that economists

will agree that price directly affects sales volumes. If a price is too high and the market

competitive, sales will fall.

On the other hand, many marketers have found ways to reduce the impact of price. In the

case of non-profit organisations there simply is no price (eg seeing a doctor) and as such

may not be applicable.

On the other hand, some principles can still be applied if ‘price’ is replaced by the

‘perceived value’ to the customer. In this way the customers put a value (often a high

value) on the service, and this can be dealt with much as price is itself.

5

THEORY OF PRICING

Much of the theory of pricing is derived from that of economics. The basic idea is that,

‘Demand will be different at each price level chosen’

As can be seen from the diagram, demand normally (but not always) falls as price increases.

Demand curve

Price

Quantity demanded

6

Alternatively, supply normally increases as prices rise (the reverse of demand), gaining

the supply curve (see below).

Supply curve

Price

Quantity supplied

7

In theory, prices changed will be set such that demand and supply are equally balanced,

such that demand = supply. This point is called the equilibrium price, as shown below.

Price

£

Demand

Supply

Equilibrium Price

Quantity

8

The problem with economic theory is it discounts to a great extent. The fact that buyers

today are no longer restricted to buying essentials but can indulge in choice products,

including luxuries. The suppliers of these products differentiate them (via the marketing

mix) such that they can be more flexible with their pricing.

Price Elasticity of Demand – Different markets for products ad services have different

levels of sensitivity towards the prices changed. The degree to which demand is sensitive

to price is called ‘price elasticity of demand’.

Definition - Price elasticity of demand is the percentage change in the quantity of a good demanded, divided by the corresponding percentage change in its price,

or

price elasticity of demand = change of demand (%)

change of price (%)

9

In the commodities market, for example, where products such as; salt, cement, oil etc

are often undifferentiated, the demand for your product will be very dependent on the

price you seek.

Where a company sets it commodity prices above the market price it is unlikely to sell its

product. Here the products price is said to be elastic.

At the other end of the spectrum there are products that are very insensitive in terms of

price. These products or services are often highly differentiated such that the market is

willing to pay a higher price.

Products and services are often branded to reflect this differentiation and so claim a

premium price. Demand for such products/brands are often called ’price inelastic’.

10

PRICING OBJECTIVES

Survival – Under service competitive pressure, in order to survive companies will cut prices

to the extent they do not cover all their costs – so long as it generates cash to keep the

company going.

Profit Maximisation – In the long-term all companies must make profits otherwise their

future will be uncertain.

Sales Maximisation – Generating lots of sales can lead to reduced unit costs and so make

the company more profitable as well as dominant in its market sector.

Price competition – A competitive price is not necessarily the lowest price, but it is one that

gives the company a competitive advantage in the marketplace. For example, Gillette razor

blades are often priced higher than their competitors because they are perceived to provide

a much higher quality than their competitors. This quality leadership means they can change

and are expected to change to a higher price. Rolls Royce cars are expensive products that

maintain their competitive edge in international markets because of the combination of

benefits offered through the marketing mix, including a high price.

11

Variable Costs

Fixed Costs

Margin

12

STRATEGIC DTERMINANTS OF PRICE

There are 3 major influences on pricing decisions. These are -

Costs

The quantity of products sold ( ie sales volume) is a critical factor in the success of any business. The reason is that every business has to pay 2 different kinds of costs associated with sales, fixed costs and variable costs.

Types of Costs

Fixed Costs – Are so called because they remain the same mo matter how many units of product are sold. (Such costs include; rent, rates, heating, lighting, wages, depreciation, insurance etc.)

Variable Costs – Are those that vary directly according to the number of units produced/sold. (Such costs include; materials and components, machine running time etc)

Cost

CompetitionDemand

13

The difference between the variable cost per unit of product and the price paid by the customer is called the margin. While the rates of variable costs to the margin remains constant no matter how many units are sold, the rates of fixed costs to margin changes with the number of units sold. For example;If your fixed costs are £1000 a year and you sell 100 units, then each unit will gave to carry £10 of fixed costs. If on the other hand you sell 500 units then each unit only has to carry £2 of fixed costs which makes a big difference when you come to price the product.

Cost Plus Pricing – The vast majority of firms price their products based on mark up on the cost providing the product or service concerned. The reason it is simple to calculate is information on costs are often well defined by accountants so firms simply add a margin to the unit cost.

The unit cost is the average cost of each item produced. If a firm produces 800 units a total cot of £24,000 the unit cost will be £30. many small businesses will tell you they ‘cost out’ each hour worked and then add a margin for profits. For example, fashion clothes sold by retailers are marked up between 75-150%.

The process if cost plus pricing can best be illustrated in relation to large firms where economies of scale can be spread over a considerable range of output. Whilst very popular, there are dangers attached. If the price is set too high, a sale will be lost; if set too low, profit will be lost.

14

Firms that operate in international markets tend to favour cost-plus pricing because it

involves using a simple formula rather than having to calculate the relative strength of

demand in lots of quite different markets. However, if this method is applied too rigidly, it

can cause problems in the marketplace.

For example, if demand is lower than expected, unit costs may be slightly higher. In this

case the accountants may well seek to raise prices. This will in turn make sales even

harder to achieve. If on the other hand, demand is higher than expected, unit costs may

fall and a price reduction may be sought which could lead to loss of revenue and profit.

15

Contribution Pricing – This involves separating out the different product that make up a

company’s portfolio in order to change individual prices appropriate to a product’s share in

total costs. We have already identified the 2 broad categories of costs: variable (direct)

costs vary with the quantity of output produced or sold; fixed (indirect) costs have to be

paid irrespective of the level of output or sales.

While it is easy to attribute direct costs to products it is not always that simple to indirect

costs, such as, wages, business, rent and rates etc. however, if we can identify the

variable costs we can at least identify each products ability to cover its direct cost and

assess how much is left over to contribute to fixed costs.

The total of all the contribution should cover all the fixed costs. Any balance is called the

profit.

Contribution is an excellent way of pricing for firms selling to a range of international

markets which share a common fixed cost base.

Revenue from Product X – Direct variable costs = Contribution of X

Revenue of Product Y – Direct variable costs = Contribution of Y

16

Demand

Demand orientated pricing involve reacting to the intensity of demand for a product, so that

high demand leads to high prices and work demand ti low prices, even though unit costs are

similar.

When a firm can segment its market into different groups, it can carry out a policy of price

discrimination. This involves selling at high prices in segments of the market where demand

is intense (ie where demand is inelastic and at relatively low prices where demand is elastic.

Customer Orientated Discrimination – Customers are often willing to pay a high price

when something is new. They also have an expectation of what price to pay. Therefore, firms

can, and often do, charge different prices for the same product at different times and in

different locations. For example, many boos are initially sold in hardbook at a high price, but

when the innovator section of the market is satisfied, a cheaper paperback version is

released at a lower price to attract other market sectors.

Time Orientated Discrimination – Demand for a service or product can vary by season or

even the time of day. At these peak demand time, products/service are often charged at a

high price and at off peak time at a lower price. This applies to a wide variety of items from

fashion clothes to train and air services.

17

Product Orientated Discrimination – Slight modification to products can allow for high

and low price strategies. For example, many car models have additional extras (eg 2 or

4 door version, with or without sunroof etc). Customers have a choice of the cheaper

basic model or a more expensive version.

Situation Orientated Discrimination – Products or services can change more or less

based on their situation or location. For example, demand for houses can very dependant

on the location of the house, cinema and theatre seats may be priced according to their

proximity to the screen or stage.

18

Competition

The nature and extent of competition is frequently an important influence on price. If

forced by direct competition, then the product will compete against very similar products

in the marketplace and as such with little differentiation prices will need to be I line with

rival prices.

In contrast, when a product is faced with indirect competition (ie competition with

products in different sectors of the market) then there will be more scope to vary price.

For example, a firm may choose a high price strategy to give a product or brand a

‘quality’ feel. In contrast, it might change a low price so that consumers view the product

as a bargain.

19

However, Hatton and Oldroyd have shown there is a price floor and a price ceiling in

which marketers can set prices, as shown below -

Price Ceiling

Demand

What the market will

Costs

Price Floor

Competitors Price Range

Within this band, there may be agreement between competitors (eg petrol/cigarettes) to avoid retaliatory responses.

20

POSITIONING AND LIFE CYCLES

The price a company sets impacts on the position of its products the competition in

terms of quality.

It may be necessary to change the price of a product as it moves through its life cycle

and hence needs to be repositioned.

Introduction - High performance costs – high prices

Growth - High performance costs but also sales growth – prices become more competitive.

Maturity - Lower promotional costs – Sales growth slow, profit taken, prices stabilise at level determined by market share/volume/demand relationships.

Decline - Minimal promotional costs

Sales decline

Prices reduced

21

PRICING STRATEGIES

Pricing can be used as an in tool to pursue short term marketing and selling targets for a

company. Typical attack based policies/strategies include –

Market Skimming – Often used when launching anew product into a market where there is

little direct competitions in the market so demand for the product may be somewhat inelastic.

Skimming involves setting a relatively high (or very high) initial price in order to yield high

returns from the consumers willing to buy the product as shown below -

Skimming pricing Destroy pricing

Penetration pricing Promotional pricing

First layer of customers

Second layer

Third layer

etc

22

Market Penetration – This method offers low prices to attract large numbers of

customers and so gain market share by penetrating the existing market. The method

works best where demand is relatively elastic and increased sales can have a great

effect on reducing the unit cost per sale.

High fixed costs Demand elastic Economies of scale Lots of customers

Penetration pricing

Leads to increased sales and

market share

A typical example would be a new breakfast cereal or a product launched in a new overseas market.

Initially it would be launched with a relatively low price, coupled to discounts and special offers. As the product penetrates the market, sales and profitability increase. Prices can then creep upwards.

23

Destroyer Pricing – This policy can be used to undermine the sales of rivals or to warn

potential new rivals not to enter the market. Destroyer pricing involves reducing the price

of an existing product at an artificial low price in order to destroy competitor sales as

shown below –

When entered the UK market in the mid 90s, British supermarkets slashed their prices

in the localities close to the new stores in an attempt to kill off the American rival.

Supermarkets continue to practice similar tactics in their local business environments in

order to close down the number of local independent traders around them.

Price

Natural Market Price

Price which yields lowest acceptable long-term return on capital invested

Destroyer price range

24

Promotional Pricing – This policy is used to inject fresh life into an existing product or to

create new interest in a new product. It can help to increase the rate at which the product

is turned over, which can reduce stock levels. Loss leaders are products whose price has

been reduced in order to boast its sales, but also the sales of products closely associated

to it.