Chapter 9: Pricing-Understanding and Capturing Customer Value
What is a Price?
•Narrowly, price is the amount of money charged for a product or service.
•Broadly, price is the sum of all the values that consumers exchange for the benefits of having or using the product or service.
•Dynamic Pricing: charging different prices depending on individual customers and situations.
Factors to consider when setting prices.
1.Customer perceptions of value
2.Other internal and external considerations
–Marketing strategy, objectives, mix
–Nature of the market and demand
–Competitors’ strategies and prices
3.Product costs
1. Customer Value Perceptions
In the end, customer will decide whether a product’s price is right. Pricing decisions like all other marketing mix elements must start with Customer value. When customers buy a product, they exchange something of value (the price) in order to get something in return (the benefits of having the product).
Value Based Pricing:
Setting price based on buyer’s perceptions of value rather than on the sellers cost.Good pricing starts with a complete understanding of the value that a product or service creates for its customers. Value based pricing means that the marketer cannot design a product and marketing program and then set the price.
Figure given below will compare value based pricing with cost based pricing.
We now examine two types of value based pricing: Good value pricing and Value added pricing.
- GOOD VALUE PRICING:
Many companies have changed their pricing approaches to bring them into line with changing economic conditions and consumer price perceptions. More and more, marketers have adopted good value pricingstrategies- offering just the right combination of quality and good service at a fair price.
An important type of good value pricing at the retail level is “every day low price” (EDLP). EDLP involves charging a constant everyday low price with few or no temporary price discounts.
In contrast, high-low pricing involves charging higher price on an everyday basis but running frequent promotions to lower prices temporarily on selected items.
2. VALUE ADDED PRICING
Attaching value added features and services to differentiate a marketing offer and support higher prices, rather than cutting prices to match competitors. In many companies, 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.
Eg: Caterpillar Company offers its dealers a wide range of value added services –from guaranteed parts delivery to investment management advice and equipment training. Such added value supports a higher price.
- Company and Product costs
- Fixed Costs:
Costs that do not vary with production or sales level.
- Variable Costs:
Costs that vary directly with the level of production.
Cost-Based Pricing
The simplest pricing method is cost plus pricing- adding a standard markup to the cost of the product.
Another cost oriented pricing approach is break even pricing (Target profit Pricing). The firm tries to determine the price at which it will break even or make the target profit it is seeking. Target pricing uses the concept of break even chart which shows a total cost and total revenue expected at different sales volume levels. Figure given below shows an example of a break even chart.
- Other internal and external considerations affecting price decisions
Customer perceptions of value set the upper limit for prices and costs set the lower limit. However in setting prices within these limits, the company must consider a number of other internal and external factors. Internal factors affecting pricing include the company’s overall marketing strategy, objectives, and marketing mix as well as other organization’s considerations. External factors include the nature of the market and demand, competitor’s strategies and prices and other environmental factors.
Overall marketing strategy, objectives and mix:
Price is the only one element of the company’s broader marketing strategy. Thus before setting price, the company must decide on its overall marketing strategy for the product or service. If the company has selected its target market and positioning carefully, then its marketing strategy including price will be fairly straight forward. For example, positioning of Toyota’s Lexus cars in the higher income segment required a higher price while the positioning of an ordinary model of Toyota’s Echo model cars requires low prices. Thus pricing strategy is largely determined by decisions on market positioning.
General pricing objectives might include survival, current profit maximization, market share leadership or customer retention or relationship building. At a more specific level, a company can set prices to attract new customers or to profitably retain existing ones.
Price is the only one of the marketing mix tools that a company uses to achieve its marketing objectives. Price decisions must be coordinated with product design, distribution and promotion decisions to form a consistent and effective marketing program.
Companies often position their products on price and then tailor other marketing mix decisions to the prices they want to charge. Here price is a crucial product positioning factor that defines the product’s market, competition and design. Many firms support such price positioning strategies with a technique called “TARGET COSTING”, a potent strategic weapon. Target costing reverses the usual process of first designing a new product, determining its cost and then asking “Can we sell it for that price?” Instead it starts with an ideal selling price based on customer value considerations, and then targets costs that will ensure that the price is met.
Organizational considerations:
Management must decide who within the organization should set prices. Companies handle pricing in a variety of ways. In small companies, prices are often set by top management rather than by the marketing or sales departments. In large companies, pricing is usually handled by divisional or product line managers. In industrial markets, sales people may be allowed to negotiate with the customers within certain price ranges. Even so top management sets the pricing objectives and policies, and it often approves the prices proposed by lower level management or sales people.
The market and Demand
Pricing in different types of Market:
The sellers pricing freedom varies with different types of markets. Economists recognize four types of markets, each presenting a different price challenge. They are as follows
1.Pure competition
2.Monopolistic competition
3.Oligopolistic competition
4.Pure monopoly
Under pure competition, the market consists of many buyers and sellers trading in a uniform commodity such as wheat, copper, or financial securities such as stocks or bonds. No single buyer or seller has much effect on the going market place. A seller cannot charge more than the going price because buyers can obtain as much as they need at the going price. If price and profits rise, new sellers can easily enter the market. In a purely competitive market, marketing research, product development, pricing, advertising and sales promotion play little or no role.
Under monopolistic competition, the market consists of many buyers and sellers who trade over a range of prices rather than a single market price. A range of prices occurs because sellers can differentiate their offers to buyers. Any physical product can be varied in quality, features, or style or the accompanying services can be varied. Buyers see the differences in sellers products and will pay different prices for them. Because there are many competitors in such markets, each firm is less affected by competitors pricing strategies than in oligopolistic markets.
Under oligopolistic competition, the market consists of a few sellers who are highly sensitive to each other’s pricing and other marketing strategies. The product can be uniform (steel, aluminum etc) or non uniform (cars, computers etc). There are few sellers because it is difficult for new sellers to enter the market. Each seller is alert to competitor’s strategies and moves. If one of the companies suddenly reduces the price of its products, buyers will quickly switch to that supplier.
In a pure monopoly, the market consists of one seller. The seller may be a government monopoly or a private regulated monopoly. In a regulated monopoly, the government permits the company to set prices that yield a fair return. In a non regulated monopoly, companies are free to set up any price that market will bear.
Price elasticity of demand:
Price elasticity of demand is the measure of the sensitivity of demand to changes in price. If demand of the product is not changing with the changes of the price, we say the demand is inelastic. If the demand changes greatly with a small change in price, we say demand is elastic.
New Product pricing strategies:
Companies bringing out a new product face the challenge of setting prices for the first time. They can choose two broad strategies: market skimming pricing and market penetration pricing strategies.
Market skimming pricing:
–Set a high price for a new product to “skim” revenues layer by layer from the market.
–Company makes fewer, but more profitable sales
When to UseMarket skimming pricing:
–Product’s quality and image must support its higher price.
–Costs of low volume cannot be so high they cancel the advantage of charging more.
–Competitors should not be able to enter market easily and undercut the price.
Market Penetration:
–Set a low initial price in order to “penetrate” the market quickly and deeply.
–Can attract a large number of buyers quickly and win a large market share.
When to UseMarket Penetration:
–Market is highly price sensitive so a low price produces more growth.
–Costs must fall as sales volume increases.
–Need to keep competition out or effects are only temporary.
Product Mix pricing strategies:
The strategy for setting a product’s price often has to be changed when the product is part of the product mix. In this case, firm looks for a set of prices that maximizes the profits on the total product mix. We now take a closer look at the five product mix pricing situations given below.
1.Product line pricing
2.Optional-product pricing
3.Captive-product pricing
4.By-product pricing
5.Product bundle pricing
Product-Line Pricing
- Involves setting price steps between various products in a product line based on:
–Cost differences between products
–Customer evaluations of different features
–Competitors’ prices
In a product line pricing, management must decide on the price steps to set between the various products in a line.
Optional- and Captive-Product Pricing
- Optional-Product
–Pricing optional or accessory products sold with the main product (e.g., ice maker with the refrigerator).
- Captive-Product
–Pricing products that must be used with the main product (e.g., replacement cartridges for Gillette razors).
By-Product and Product Bundle Pricing Strategies
- By-Product Pricing
–Pricing low-value by-products to get rid of them (e.g., animal manure from zoo).
- Product Bundle Pricing
–Pricing bundles of products sold together (software, monitor, PC, and printer).
Price Adjustment Strategies
Companies usually adjust their basic prices to account for various customer differences and changing situations. Here we examine the seven price adjustment strategies and the names of these strategies are given below.
1.Discount and allowance pricing
2.Segmented pricing
3.Psychological pricing
4.Promotional pricing
5.Geographical pricing
1. DISCOUNTS AND ALLOWANCES
A discount is a straight reduction in price on purchases during a stated period of time. Most companies give these discounts and allowances for certain response from the customers such as early payment of bills, volume purchases and off-season buying.
A quantity discount is a price reduction to buyers who buy large volumes. Such discounts provide an incentive to the customer to buy more from one given seller rather than from many different sources.
A functional discount who perform certain functions( also called trade discount) is offered by seller to trade channel members who perform certain functions such as selling, storing, record keeping.
A seasonal discount is a price reduction to buyers who buy merchandise or services out of season. Seasonal discounts allow the seller to keep production steady during an entire year.
Allowances are another type of reduction from the list price. They are the promotional money paid by the manufacturers to retailers in return for an agreement to feature the manufacturer’s products in some way.
Trades 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.
2. SEGMENTED PRICING
Selling a product or service at two or more prices, where the difference in prices is not based on differences in costs.
Types:
- Customer-segment
- Product-form
- Location pricing
- Time pricing
3. PSYCHOLOGICAL PRICING
- Considers the psychology of prices and not simply the economics.
- Consumers usually perceive higher-priced products as having higher quality.
- Consumers use price less when they can judge the quality of a product by examining it or recalling experiences.
4. PROMOTIONAL PRICING
With promotional pricing, companies will temporarily price their products below list price and sometimes even below cost to create buying excitement and urgency.
Supermarkets and department stores will price a few products as loss leaders to attract customers to the shop in the hope that they will buy other items at normal markups. The other forms of promotional pricing are given below.
- Low-Interest Financing
- Longer Warranties
- Free Maintenance
- Cash Rebates
- Special-Event Pricing
5.GEOGRAPHICAL PRICING
A company must also decide how to price its products for customers located at different parts of the country or world. We will look at five geographical pricing strategies.
1.FOB-origin pricing
This practice means that the 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.
2.Uniform-delivered pricing
Uniform delivered pricing is the opposite of FOB pricing. Here the company charges the same price plus freight to all customers, regardless of their location. The freight charge is set at the average freight cost.
3.Zone pricing
Zone pricing falls between FOB origin pricing and uniform delivered pricing. The company sets two or more zones. All customers within a given zone pay a single total price, the more distant the zone, the higher the price.
4.Basing-point pricing
Using the basing point pricing, the seller selects a given city as 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 shipped.
5.Freight-absorption pricing
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. The seller might reason that if it can get more business, its average cost will fall and more than compensate for its extra freight cost.