Topic 6: Pricing strategies Flashcards
Answer the question “What is a price?” and discuss the importance of pricing in today’s fast-changing environment.
Price can be defined narrowly as the amount of money charged for a product or service. Or it can be defined more broadly as the sum of the values that consumers exchange for the benefits of having and using the product or service. The pricing challenge is to find the price that will let the company make a fair profit by getting paid for the customer value it creates.
Despite the increased role of nonprice factors in the modern marketing process, price remains an important element in the marketing mix. It is the only marketing mix element that produces revenue; all other elements represent costs. More important, as a part of a company’s overall value proposition, price plays a key role in creating customer value and building customer relationships. Smart managers treat pricing as a key strategic tool for creating and capturing customer value.
Identify the three major pricing strategies and discuss the importance of understanding customer value perceptions, company costs, and competitor strategies when setting prices.
Companies can choose from three major pricing strategies: customer value-based pricing, cost-based pricing, and competition-based pricing.
- Customer value-based pricing uses buyers’ perceptions of value as the basis for setting price. Good pricing begins with a complete understanding of the value that a product or service creates for customers and setting a price that captures that value. Customer perceptions of the product’s value set the ceiling for prices. If customers perceive that a product’s price is greater than its value, they will not buy the product. Value-based pricing means that the marketer cannot design a product and marketing program and then set the price. Price is considered along with all other marketing mix variables before the marketing program is set. Companies can pursue either of two types of value-based pricing.
- Good-value pricing involves offering just the right combination of quality and good service at a fair price. EDLP is an example of this strategy. EDLP = everyday low pricing, in contrast to high-low pricing, which involves charging higher prices on an everyday basis but running frequent promotions to lower prices temporarily on selected items (sale days, early-bird savings, bonus earnings).
- Value-added pricing involves attaching value-added features and services to differentiate the company’s offers and support charging higher prices.
- Cost-based pricing involves setting prices based on the costs for producing, distributing, and selling products plus a fair rate of return for effort and risk. Company and product costs are an important consideration in setting prices. Whereas customer value perceptions set the price ceiling, costs set the floor for pricing. However, cost-based pricing is product driven rather than customer driven. The company designs what it considers to be a good product and sets a price that covers costs plus a target profit. If the price turns out to be too high, the company must settle for lower markups or lower sales, both resulting in disappointing profits. If the company prices the product below its costs, its profits will also suffer. Cost-based pricing approaches include cost-plus pricing and break-even pricing (or target profit pricing).
- Competition-based pricing involves setting prices based on competitors’ strategies, costs, prices, and market offerings. Consumers base their judgments of a product’s value on the prices that competitors charge for similar products. If consumers perceive that the company’s product or service provides greater value, the company can charge a higher price. If consumers perceive less value relative to competing products, the company must either charge a lower price or change customer perceptions to justify a higher price.
What is the approach for cost-based pricing versus value-based pricing?
What are the types of costs?
- Fixed cost: are also known as overhead. These are costs that do not vary with production or sales levels, e.g. rent, heat, interest, etc.
- Variable costs are costs that vary directly with the level of production.
Total costs are the sum of the fixed and variable costs for any given level of production.
Identify and define the other important external and internal factors affecting a firm’s pricing decisions.
Other internal factors that influence pricing decisions include the company’s overall marketing strategy, objectives, and marketing mix, as well as organizational considerations. Price is only one element of the company’s broader marketing strategy. If the company has selected its target market and positioning carefully, then its marketing mix strategy, including price, will be fairly straightforward. Common pricing objectives might include customer retention and building profitable customer relationships, preventing competition, supporting resellers and gaining their support, or avoiding government intervention. Price decisions must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective marketing program. Finally, in order to coordinate pricing goals and decisions, management must decide who within the organization is responsible for setting price.
Other external pricing considerations include the nature of the market and demand and environmental factors such as the economy, reseller needs, and government actions. Ultimately, the customer decides whether the company has set the right price. The customer weighs the price against the perceived values of using the product – if the price exceeds the sum of the values, consumers will not buy. So the company must understand such concepts as demand curves (the price–demand relationship) and price elasticity (consumer sensitivity to prices).
Economic conditions can have a major impact on pricing decisions. The Great Recession (2008-2009) caused consumers to rethink the price–value equation, and consumers have continued their thriftier ways well beyond the economic recovery. Marketers have responded by increasing their emphasis on value-for-the-money pricing strategies. No matter what the economic times, however, consumers do not buy based on prices alone. Thus, no matter what price they charge – low or high – companies need to offer superior value for the money.
Describe the major strategies for pricing new products.
Pricing is a dynamic process, and pricing strategies usually change as the product passes through its life cycle. The introductory stage – setting prices for the first time – is especially challenging. The company can decide on one of several strategies for pricing innovative new products: It can use market-skimming pricing by initially setting high prices to “skim” the maximum amount of revenue from various segments of the market. Or it can use market-penetrating pricing by setting a low initial price to penetrate the market deeply and win a large market share. Several conditions must be set for either new product pricing strategy to work.
Explain how companies find a set of prices that maximizes the profits from the total product mix.
When the product is part of a product mix, the firm searches for a set of prices that will maximize the profits from the total mix.
- In product line pricing, the company determines the price steps for the entire product line it offers (Setting the price steps between various products in a product line based on cost differences between the products, customer evaluations of different features, and competitors’ prices).
- In addition, the company must set prices for optional products (optional or accessory products included with the main product), e.g. having a basic model car and then purchasing additional features.
- captive products (products that are required for using the main product), e.g. games for a video-game console, blades for a razor, printer catridges.
- by-products (waste or residual products produced when making the main product). If the by-products have no value and getting rid of them is costly, then they affect the pricing of the main product.
- and product bundles (combinations of products at a reduced price), e.g. food combos, Zuku bundling TV, phone and internet.
Discuss how companies adjust their prices to take into account different types of customers and situations.
Companies apply a variety of price adjustment strategies to account for differences in consumer segments and situations.
- One is discount and allowance pricing, whereby the company establishes cash, quantity, functional, or seasonal discounts, or varying types of allowances such as trade-in, promotional.
- A second strategy is segmented pricing, where the company sells a product at two or more prices to accommodate different customers, product forms, locations, or times. E.g. customer-segmented pricing like in student pricing for movies, product form pricing like economy class vs business class, location-based pricing e.g. higher tuition for out-of-state students, time-based pricing e.g. offers on lunch time movies and resorts giving weekend and seasonal discounts.
- Sometimes companies consider more than economics in their pricing decisions, using psychological pricing to better communicate a product’s intended position. Another aspect of psychological pricing is reference prices – 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.
- In promotional pricing, a company offers discounts or temporarily sells a product below list price as a special event, sometimes even selling below cost as a loss leader. Promotional pricing takes several forms. A seller may simply offer discounts from normal prices to increase sales and reduce inventories. Sellers also use special-event pricing in certain seasons to draw more customers. Thus, TVs and other consumer electronics are promotionally priced in November and December to attract holiday shoppers into the stores. Limited-time offers, such as online flash sales, can create buying urgency and make buyers feel lucky to have gotten in on the deal. Manufacturers sometimes offer cash rebates to consumers who buy the product from dealers within a specified time; the manufacturer sends the rebate directly to the customer. Rebates have been popular with automakers and producers of mobile phones and small appliances, but they are also used with consumer packaged goods. Some manufacturers offer low-interest financing, longer warranties, or free maintenance to reduce the consumer’s “price.” This practice has become another favorite of the auto industry.
- Another approach is geographical pricing, whereby the company decides how to price to distant customers, choosing from such alternatives as FOB-origin pricing (A geographical pricing strategy in which goods are placed free on board a carrier; the customer pays the freight from the factory to the destination), uniform-delivered pricing (A geographical pricing strategy in which the company charges the same price plus freight to all customers, regardless of their location), zone pricing (A geographical pricing strategy in which the company sets up two or more zones. All customers within a zone pay the same total price; the more distant the zone, the higher the price), basing-point pricing (A geographical pricing strategy in which the seller designates some city as a basing point and charges all customers the freight cost from that city to the customer), and freight-absorption pricing (A geographical pricing strategy in which the seller absorbs all or part of the freight charges in order to get the desired business).
- Using dynamic pricing, a company can adjust prices continually to meet the characteristics and needs of individual customers and situations (e.g. Black Friday pricing wars or Uber’s surge pricing).
- Finally, international pricing means that the company adjusts its price to meet different conditions and expectations in different world markets.
Discuss the key issues related to initiating and responding to price changes.
When a firm considers initiating a price change, it must consider customers’ and competitors’ reactions. There are different implications to initiating price cuts and initiating price increases. Buyer reactions to price changes are influenced by the meaning customers see in the price change. Competitors’ reactions flow from a set reaction policy or a fresh analysis of each situation.
There are also many factors to consider in responding to a competitor’s price changes. The company that faces a price change initiated by a competitor must try to understand the competitor’s intent as well as the likely duration and impact of the change. If a swift reaction is desirable, the firm should preplan its reactions to different possible price actions by competitors. When facing a competitor’s price change, the company might sit tight, reduce its own price, raise perceived quality, improve quality and raise price, or launch a fighter brand.
Overview the social and legal issues that affect pricing decisions.
Many federal, state, and even local laws govern the rules of fair pricing. Also, companies must consider broader societal pricing concerns. The major public policy issues in pricing include potentially damaging pricing practices within a given level of the channel, such as price-fixing and predatory pricing. They also include pricing practices across channel levels, such as retail price maintenance, discriminatory pricing, and deceptive pricing. Although many federal and state statutes regulate pricing practices, reputable sellers go beyond what is required by law. Treating customers fairly is an important part of building strong and lasting customer relationships.
