Pricing Products and Services

Pricing Products and Services

I Nature and Importance of Price

A. What is a Price?

* Price is the money or other considerations (including other goods

and services) exchanged for the ownership or use of a good or

service.

• Barter - the practice of exchanging goods and services for other

goods and services rather than for money accounts for billions

of dollars annually in domestic and international trade.

B. Price as an indicator of value

* Price is often used to indicate quality or value when it is compared

With the perceived benefits of a product or service.

• Creative marketers engage in value pricing - the practice of

simultaneously increasing product and service benefits while

maintaining or decreasing price.Example: “supersizing”

C. Price in the Marketing Mix

*Pricing has a direct effect on a firm’s profits. This is apparent

from a firms profit equation:

Profit = total revenue - total cost

Profit =(unit price x quantity sold) - total cost

II General Pricing Approaches

A key to a marketing manager’s setting a final price for a product is to find an approximate price level to use as a reasonable starting point.

A. Demand-Oriented Approaches

Demand -oriented approaches emphasize factors underlying expected customer tastes and preferences more than such factors as cost, profit, and competition when selecting a price level.

1. Skimming Pricing

a. A firm introducing a new or innovative product can use

skimming pricing, setting the highest initial price that customers

really desiring the product are willing to pay.

b. These customers are not very price sensitive. They weigh

the new product’s price and quality against the same

characteristics of substitutes.

c. As consumer demand is satisfied, the firm lowers the price

to attract another, more price sensitive segment

d. Skimming pricing gets its name from skimming successive layers

of “cream” or customer segments, as prices are lowered in a

series of steps.

2. Penetration Pricing

a. Setting a low initial price on a new product to appeal

immediately to the mass market. Penetration Pricing is

the exact opposite of skimming pricing.

b. Penetration pricing may follow skimming pricing:

* A company might initially price a product high to

attract price-insensitive consumers and recoup initial

R&D costs and introductory promotional expenses.

Then use penetration pricing to appeal to a broader

segment of the population and increase market share.

3. Prestige Pricing

a. Prestige Pricing - setting a high price so that quality- or

status conscious consumers will be attracted to the product

and buy it.

b. Although consumers tend to buy more of a product when the

price is lower, sometimes the reverse is true.

4. Odd-Even Pricing

a. Odd-even pricing - setting prices a few dollars or cents

under an even number ($499.99 vs. $500.00).

The overuse of odd-even pricing tends to reduce its

effect on demand.

5. Target Pricing

a. Manufacturers will sometimes estimate the price that the

ultimate consumer is willing to pay for a product. They

then work backward through markups taken by retailers

and wholesales to determine what price they can charge

to wholesalers for the product.

b. In target pricing, the manufacturer deliberately adjusts

the composition and features of a product to achieve the

target price to consumers.

6. Bundle Pricing

a. Bundle Pricing is the marketing of two or more products in

a single package price and is based on the idea that consumers

value the package more than the individual items.

b. Bundle Pricing provides buyers with a lower total cost, not

having to make separate purchases.

7. Yield Management Pricing

a. Yield management pricing is the charging of different prices

to maximize revenue for a set amount of capacity at any

given time.

b. This is often used by airlines, hotels, car rental firms engaged

in capacity management by varying prices based on time, day

week, or season to match demand and supply.

B. Cost-Oriented Approaches

With cost-oriented approaches, a price setter stresses the cost side of the pricing problem, not the demand side. Price is set by looking at the production and marketing costs and then adding enough to cover direct expenses, overhead, and profit.

1. Standard Markup Pricing - adding a fixed percentage to the cost

of all items in a specific product class.

a. This percentage markup varies depending on the type of retail

store and product involved.

b. High volume products usually have smaller markups than low-

volume products

c. These markups must cover all expenses of the store, pay for

overhead costs, and contribute something to profits. For super-

markets this may be only 1 percent.

2. Cost plus Pricing

a. Many manufacturers, professional services, and construction firms

use this variation of standard markup pricing.

b. cost plus pricing involves summing the total unit cost of providing

a product or service and adding a specific amount to the cost

to arrive at a price.

c. Cost plus pricing is the most commonly used method to set prices

for business products or business-to-business marketers in the

service sector.

C. Profit-Oriented Approaches

A price setter may balance both revenues and cost to set price by either setting a target of a specific dollar volume of profit or expressing this target profit as a percentage of sales or investment.

1. Target Profit Pricing

a. Target Profit pricing - setting an annual target of a specific dollar

volume of profit.

b. To calculate a target profit price for a picture frame store:

Profit= total revenue - total cost

= (Price x Quantity sold) - (fixed Cost + (Unit Variable Cost x Quantity sold))

c. This method depends on an accurate estimate of demand. Because

demand is difficult to estimate, this method has the potential for

disaster if the estimate is too high.

2. Target Return - on- sales Pricing

a. Target return on sales pricing involves setting a rice to achieve

a profit that is a specified percentage of the sales volume

b. Supermarkets often use this method due to the difficulty in

establishing a benchmark of sales or investment to show how

much of a firm’s effort is needed to achieve the target.

3. Target Return on Investment Pricing

Involves setting a price to achieve an annual target return on

Investment (ROI) that is mandated by a board of directors or

regulators.

D. Competition-oriented Approaches

Rather than emphasize demand, cost, or profit factors, a price setter can stress what competitors or “the market” is doing.

1. Customary Pricing

a. Customary pricing - setting a price dictated by tradition, a

standardized channel of distribution, or other competitive

factors.

b. A significant departure from this price may result in the loss

of sales for the manufacturer.

2. Above - At or Below Market Pricing

a. The “market price” of a product is what customers are

willing to pay, not necessarily the price that the firm sets.

b. Set a market price for a product or product class based on a

subjective feel for the competitors’ price or market price

as a benchmark.

c. Above-market pricing sets a premium price for a product.

d. At market pricing establishes the going market price or

reference point in the minds of their competitors

e. Below market pricing sets a market price below the prices

of nationally branded competitive products to promote a value

image among buyers.

3. Loss-Leader Pricing

Deliberately selling a product below its customary price, not to

Increase sales but to attract customers attention in the hopes that

They will buy other products as well, such as discretionary items

with large markups.

III ESTIMATING DEMAND AND REVENUE

Marketing Executives must also translate the estimate of customer demand into estimates of revenues the firm expects to receive.

*How much would consumers be willing to pay for a product? If the

price kept going up, at some point they will quit buying it.

Conversely, if the price kept going down, they would buy more.

• How much more of a product needs to be sold to make up for the

lower price per unit? The answer depends on the demand curve.

1. The demand curve - a graph relating quantity sold and price, which shows the maximum number of units that will be sold

at a given price.

2 Price Elasticity of Demand

a. Marketers are especially interested in how sensitive consumer

demand and the firm’s revenues are to changes in the product’s

price.

b. This is measured by price elasticity of demand, the percentage

change in quantity demanded relative to a percentage change in price.

*A product with elastic demand is one in which a slight

decrease in price results in a relatively large increase

in demand, or units sold.

• A product with inelastic demand means that slight

increases or decreases in price will not significantly affect

the demand, or units sold for the product.

IV DETERMINING COST, VOLUME, AND PROFIT RELATIONSHIPS

While revenues are the monies received by the firm from selling its

Products or services to customers, costs or expenses are the monies the

Firm pays out to its employees and suppliers.

A. The Importance of Controlling Costs

* Total Cost (TC) is the total expense incurred by a firm in producing

And marketing a product. Total cost is the sum of fixed cost and

Variable cost, or TC= FC + VC

• Fixed Cost (FC) is the sum of the expenses of the firm that are stable. For example, rent on the building, executive salaries
• Variable Cost (VC) is the sum of the expenses of the firm

that vary directly with the quantity of a product that is produced

and sold, such as the direct labor, direct materials and sales

commissions.

• Variable Cost expressed on a per unit basis is called unit variable

Cost (UVC)

Many firms go bankrupt because their costs get out of control,

causing their total costs to exceed their total revenues over an

Extended period of time.

B. Break Even Analysis

* Break even analysis - is a technique that analyzes the relationship

between total revenue and total cost to determine profitability at

various levels of output.

• The break even point (BEP) is the quantity at which total revenue

and total cost are equal. Profit then comes from all units sold

beyond the BEP.

BEP = Fixed Cost

Unit Price - Unit Variable Cost

BEP = Fixed Cost divided by (Price - Unit Variable Cost)

For example: Using a small picture frame store, a BEP (break even point) quantity for the number of pictures needed to be sold to cover fixed costs can be calculated. IF FC (fixed costs) = $28,000

P (price) = $100 and UVC = $30, the BEP is:

BEP = $28,000

$100 - $30

BEP = 400 pictures

At less than 400 pictures the picture frame store incurs a loss

At more than 400 pictures, the picture frame store makes a profit.

V SETTING A FINAL PRICE

The final price set by the marketing manager serves many functions:

• It must be high enough to cover the cost of providing the product

and meet the objectives of the company

• It must be low enough that customers are willing to pay it. But

not too low, or they may think they’re purchasing an inferior

product.

Step 1. Select an Approximate Price level

• Consider pricing objectives and constraints first, then choose among the general pricing approaches - demand, cost, profit,

or competition-oriented - to arrive at an approximate price level

Step 2 Set the list or Quoted Price

A seller must decide to follow a one-price or flexible price policy.

*A one price policy involves setting one price for all buyers of

a product or service.

*A Flexible price policy sets different prices for products and services depending on individual buyers and purchase situations in light of demand, cost and competitive factors.

Step 3 Make Special Adjustments for the List or Quoted Price

If a firm sells its products to multiple wholesalers and retailers in the distribution channel, it will make a number of adjustments to the list price.

1. Discounts - are reductions from list price that a seller gives a

Buyer as a reward for some activity of the buyer that is favorable

to the seller.

a. Quantity Discounts - reductions in unit costs for an large quantity

order. These are offered to all firms in the distribution channel.

b. Seasonal discounts - used by manufacturers to encourage buyers

to stock inventory earlier than their normal demand would require.

c. Trade discounts - are used by manufacturers to reward wholesalers

and retailers for marketing functions they will perform in the future.

d. Cash discounts - Are used by manufacturers to encourage retailers

to pay their bills quickly.

2. Allowances - like discounts - are also reductions from list

or quoted prices.

a. Trade in allowances - are price reductions given when a

used product is part of the payment on a new product.

b. Promotional allowances - actual cash payments or extra

free goods sellers in the channel can qualify for.

c. Everyday low pricing - is the practice of replacing promotional

allowances with lower manufacturer list prices.

3. Geographical Adjustment

Are made by manufacturers or even wholesalers to list or quoted

prices to reflect the cost of transportation of the products from seller

to buyer.

a. FOB Free on board some vehicle at some location.

b. Uniformed delivered pricing - the price the seller quotes includes all transportation.