CHAPTER

14

LEARNING OBJECTIVES

DEVELOPING PRICING STRATEGIES AND PROGRAMS

In this chapter, we will address the following questions: 1. How do consumers process and evaluate prices? 2. How should a company set prices initially for products or services? 3. How should a company adapt prices to meet varying circumstances and opportunities? 4. When should a company initiate a price change? 5. How should a company respond to a competitor’s price change? CHAPTER SUMMARY 1) Despite the increased role of nonprice factors in modern marketing, price remains a critical element of the marketing mix. Price is the only element that produces revenue; the others produce costs. 2) In setting pricing policy, a company follows a six-step procedure. It selects its pricing objective. It estimates the demand curve, the probable quantities it will sell at each possible price. It estimates how its costs vary at different levels of output, at different levels of accumulated production experience, and for differentiated marketing offers. It examines competitors’ costs, prices, and offers. It selects a pricing method. It selects the final price. 3) Companies do not usually set a single price, but rather a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, and other factors. Several price-adaptation strategies are available: (1) geographical pricing; (2) price discounts and allowances; (3) promotional pricing; and (4) discriminatory pricing. 4) Firms often need to change prices. A price decrease might be brought about by excess plant capacity, declining market share, a desire to dominate the market through lower costs, or economic recession. A price increase might be brought about by cost inflation or overdemand. Companies must carefully manage customer perceptions in raising prices. 5) Companies must anticipate competitor price changes and prepare a contingent response. A number of responses are possible in terms of maintaining or changing price or quality. 6) The firm facing a competitor’s price change must try to understand the competitor’s Copyright 2012 Pearson Education

intent and the likely duration of the change. Strategy often depends on whether a firm is producing homogeneous or nonhomogeneous products. A market leader attacked by lower-priced competitors can seek to better differentiate itself, introduce its own low-cost competitor, or transform itself more completely. OPENING THOUGHT Students should have a good understanding of “price” in their role as consumers. The instructor is encouraged to expand the student’s definition of “a price” by using examples of different pricing structures (cell phone plans for example), promotional pricing, geographical pricing, and price discrimination. An area for some misunderstanding for students new to marketing is how the firm reviews competitor’s reactions to price changes. Students will have some degree of difficulty in assuming the “role” of a competitor and formulating defensive and/or offensive plans to price changes. Sufficient classroom time should be spent in clarifying these roles. Discriminatory pricing is also an area that students new to marketing can have some difficulty understanding for the first time. Although discriminatory pricing is not illegal, per se, the distinctions are sometimes porous between the two. TEACHING STRATEGY AND CLASS ORGANIZATION PROJECTS 1. At this point in the semester-long marketing plan project, students should be prepared to hand in their pricing strategy decisions for their fictional product/service. In reviewing this section, the instructor should make sure that the students have addressed all or most of the material concerning pricing covered in this chapter. 2. Consumer perceptions of prices are also affected by alternative pricing strategies. Marriott Hotels, for example, has different brands for differing price points. Building upon the Marriott example, students are to scan the environment to find examples of a company whose pricing strategy is closely tied to its branding strategy. Caution: students may want to list just the different price points in the same company such as Ford automobiles. What this project is designed to accomplish, is that students should note that the Lincoln line of cars are priced at a premium to the Ford and Mercury divisions. Good students will also have researched the actual percentage difference between the three divisions. 3. Sonic PDA Marketing Plan: Pricing is a critical element in any company’s marketing plan, because it directly affects revenue and profit goals. Effective pricing strategies must consider costs as well as customer perceptions and competitor reactions, especially in highly competitive markets.

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You are in charge of pricing Sonic’s first PDA. Review your SWOT Analysis and Competition Analysis. Also, think about the markets you are targeting and the positioning you want to achieve. Then, answer the following questions about pricing: • • •

What should Sonic’s primary pricing objective be? Why? Are PDA customers likely to be price-sensitive? Is demand elastic or inelastic? What are the implications of the answers for pricing decisions? What price adaptations such as discounts, allowances, and promotional pricing should Sonic include in its marketing plan?

Document your pricing strategies and programs in a written marketing plan or type them into the Marketing Mix section of Marketing Plan Pro. ASSIGNMENTS Marketers recognize that consumers often actively process price information, interpreting prices in terms of their knowledge from prior purchasing experience, formal communications, informal communications, point-of-purchase, or online resources. Purchase decisions are based on how consumers perceive prices and what they consider to be the current actual price—not the marketer’s stated price. In small groups, ask the students to choose a service good, such as education, legal advice, tax advice, or other such services, and have them map out their perception of prices and what they consider to be the current actual price. Finally, students should compare and contrast their perceptions with the stated or published prices for these services. In completing this assignment, students should explain the differences between perception and stated prices in terms of consumer buying behavior models from Chapter 6 of this text. Many consumers use price as an indicator or quality. As a group assignment, students should choose a product produced by a firm. Subsequently, the students should conduct a small research project (utilizing the material learned from Chapter 4) and either, confirm, or deny this relationship for the chosen product. For example, do more women or men rely on price as an indicator of quality for product X? If there is a difference, what is the quantifiable difference in terms of marketing research data? Does this difference suggest that marketers must or can revise, or revamp price clues to reach their target market? Katherine Heires in Business Week 2.0, October 2006, wrote “Why it Pays to Give Away the Store.” Either in small groups or individually, have the students read Ms. Heires article and comment on the validity/invalidity of these nine suggestions as being applicable to key service companies. Table 14.1 lists some possible consumer reference prices and students should comment on whether or not these consumer reference prices are applicable today. Is this list inclusive or are there new reference points caused by the increased use of such Web sites like eBay or Craigslist?

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Table 14.3 lists nine factors that the authors contend leads to less price sensitivity in consumers. Choose a product that is available online and in stores (books or tires, for example) and ask the students to research the various pricings choices available online. After collecting this data, ask the students to comment on whether or not, the variety of price points found lowers their price sensitivity? For many firms pricing is the domain of the financial disciplines in the company. Using accepted accounting and financial processes, some companies’ price strictly according to these models. Assign students the assumed role of “defenders” of this practice and others as “innovators,” challenging these models and supporting some of the newer pricing models such as “perceived” and “value” pricing for products. Have the students come prepared to defend their positions using the concepts developed in this chapter. Paul W. Farris and David J. Reibstein, in their article, “How Prices, Expenditures, and Profits Are Linked,” Harvard Business Review (November-December 1979); pp. 173184, found a relationship between relative price, relative quality, and relative advertising (their findings are summarized in the chapter). Students should read the full report, and then be prepared to discuss the validity of this study in light of the consumer information explosion that has occurred due to the emergence of the Internet. Are these relationships still valid today? If not, why or what has caused them to change? END-OF-CHAPTER SUPPORT MARKETING DEBATE—Is the Right Price a Fair Price? Prices are often set to satisfy demand or to reflect the premium that consumers are willing to pay for a product or service. Some critics shudder, however, at the thought of $2 bottles of water, $150 running shoes, and $500 concert tickets. Take a position: Prices should reflect the value that consumers are willing to pay versus prices should primarily just reflect the cost involved in making a product or service. Pro: Price, perhaps more than any other element of the marketing mix, communicates value to the consumer. In the consumer decision-making process, we have learned that customers are value-maximizers. They form an expectation of value and act on it. A buyer’s satisfaction is a function of the product’s perceived performance and the buyer’s expectations. So, if the product meets these consumers’ value definitions and the given price point reflects these values, price is seen as acceptable. If the price and the product’s value definition in the minds of the consumer are not consistent, sales will decline and prices will drop until prices reach equilibrium with the consumers’ definition of value. Con: Marketers have an obligation to the consumers to produce products (or services) that meet consumer needs at the lowest price possible. Fair pricing does not assign any consumer “value” definition into its equation and it should not because each consumer will have differing definitions of “value” according to their prejudices. When marketers try to “assign” a “value definition” to its product, it runs the risks of alienating current customers and missing other potential customers. Therefore, assigning a “fair” price, composed of actual costs plus fair margins, allows the marketer to maximize its customer bases. Copyright 2012 Pearson Education

MARKETING DISCUSSION Think of the pricing methods described in this chapter—markup pricing, target-return pricing, perceived value pricing, value pricing, going rate pricing, and auction-type pricing. As a consumer which method do you personally prefer to deal with. Why? If the average price were to stay the same, which would you prefer: (1) for firms to set one price and not deviate, or (2) to employ slightly higher prices most of the year, but slightly lower discounted prices or specials for certain occasions. Student answers will differ. However, the following notation from research is worth reenforcing during the class discussions. • •

The two different pricing strategies have been shown to affect consumer price judgments. Deep discounts (EDLP) can lead to lower perceived prices by consumers over time than frequent shallow discounts (high-low) even if the actual averages are the same.

Marketing Excellence: EBAY 1) Why has eBay succeeded as an online auction marketplace while so many others have failed? Suggested Answer: eBay’s success truly created a pricing revolution by allowing buyers to determine what they would pay for an item; the result pleases both sides because customers gain control and receive the best possible price while sellers make good margins due to the site’s efficiency and wide reach. For years, buyers and sellers used eBay as an informal guide to market value. eBay has evolved to also offer a fixed-price “buy it now” option to those who don’t want to wait for an auction and are willing to pay the seller’s price. 2) Evaluate eBay’s fee structure. Is it optimal or could it be improved? Why? How? Suggested Answer: eBay’s pricing structure was developed to attract high-volume sellers and deter those who list only a few low-priced items. With eBay’s expansion into a wide range of other categories—from boats and cars and travel and tickets to health and beauty and home and garden—collectibles now make up only a small percentage of eBay sales and eBay can and should revisit its pricing structure to maximize profits on products that more and more people are buying—the fixed price option. 3) What’s next for eBay? How does it continue to grow when it needs both buyers and sellers? Where will this growth come from? Suggested Answer: Students answers will vary. Some might suggest that eBay will become or morph into a version of AMAZON.COM. Others think that eBay’s business plan and popularity will fade as other retailers embark on “auction” type selling—either English or Dutch auction. Copyright 2012 Pearson Education

Marketing Excellence: SOUTHWEST AIRLINES 1) Southwest has mastered the low-price model and has the financial results to prove it. Why don’t the other airlines copy Southwest’s model? Suggested Answer: Southwest’s business model is based on streamlining its operations, and is an integrated part of the corporate philosophy and structure of the company. Other airline companies would have to “discard” their entire manual of operations, labor relations, and equipment and schedules to copy the Southwest model. A few airlines are copying Southwest: JetBlue, RyanAir, and Asia Airlines to name a few. 2) What risks does Southwest face? Can it continue to thrive as a low cost airline when tough economic times hit? Suggested Answer: The risks to Southwest’s strategy are in a number of areas. Competitors copying Southwest’s low fares and point-to-point route structure is one, increased fuel costs is two, and three, consumer sentiments about flying is three. Yes, there will always be a market for the “low price” leader in any consumer category— airlines, computers, or retailers. DETAILED CHAPTER OUTLINE Price is the one element of the marketing mix that produces revenue; the other elements produce costs. Prices are perhaps the easiest element of the marketing program to adjust; product features, channels, and even promotion take more time. Price also communicates to the market the company’s intended value positioning of its product or brand. A well-designed and marketed product can command a price premium and reap big profits. But new economic realities have caused many consumers to pinch pennies, and many companies have had to carefully review their pricing strategies as a result. Pricing decisions are clearly complex and difficult, and many marketers neglect their pricing strategies. Holistic marketers must take into account many factors in making pricing decisions—the company, customers, competition, and marketing environment. Pricing decisions must be consistent with the firm’s marketing strategy and its target markets and brand positionings. UNDERSTANDING PRICING Price is not just a number on a tag or an item. Price comes in many forms and performs many functions. A) Throughout most of history prices were set by negotiation between buyers and sellers. B) Setting one price for all buyers is a relatively modern idea. C) Traditionally, price has operated as the major determinant of buyer choice. A Changing Pricing Environment Copyright 2012 Pearson Education

Pricing practices have changed significantly. At the turn of the 21st Century, consumers had easy access to credit, so by combining unique product formulations with enticing marketing campaigns, many firms successfully traded consumers up to more expensive products and services. The onset of the Great Recession—a recession more severe than previous recessions which resulted in many jobs lost and many businesses and consumers unable to receive loans due to their poorly leveraged situations—changed things though. A combination of environmentalism, renewed frugality, and concern about jobs and home values forced many U.S. consumers to rethink how they spent their money. They replaced luxury purchases with basics. Downward price pressure from a changing economic environment coincided with some longer-term trends in the technological environment. For some years now, the Internet has been changing how buyers and sellers interact. Here are some ways: 1. 2. 3. 4. 5. 6.

Get instant price comparisons from thousands of vendors. Name their price and have it met. Get products free. Monitor customer behavior and tailor offers to individuals. Give certain customers access to special prices. Negotiate prices in online auctions and exchanges or even in person.

Marketing Insight: Giving it all away Giving away products free via sampling has been a successful marketing tactic for years; today with the advent of the Internet software, product and service companies are following suit. Ryanair is an example. How Companies Price Companies do their pricing in a variety of ways. A) In small companies, prices are often set by the boss. B) Where pricing is a key factor, companies often establish a pricing department to set or assist others in setting appropriate prices. C) In large companies, top management sets general pricing objectives, policies, and … D) Effectively designing and implementing pricing strategies requires a thorough understanding of consumer pricing psychology and a systematic approach to setting, adapting, and changing prices. Consumer Psychology and Pricing Marketers recognize that consumers often actively process price information, interpreting prices in terms of their knowledge from prior purchasing experiences, formal communications, and point-of-purchase or online resources. A) Purchase decisions are based on how consumers perceive prices. Copyright 2012 Pearson Education

B) What they consider the current actual price—not the marketer’s stated price. C) Consumers may have a lower price threshold below which prices may signal inferior or unacceptable quality. D) Upper price threshold above which prices are prohibitive and seen as not worth the money. E) Consumer attitudes about pricing took a dramatic shift in the recent economic downturn as many found themselves unable to sustain their lifestyles. F) Understanding how consumers arrive at their perceptions of prices is an important marketing priority. Reference Prices When examining products, consumers often employ reference prices. A) In considering an observed price, consumers often compare it to an internal reference price (pricing from memory). B) An external frame of reference (posted “regular retail price”). C) All types of reference prices are possible. a. “fair price” b. Typical price c. Last price paid d. Upper-Bound price e. Lower-Bound price f. Historical competitor price g. Expected future price h. Usual discounted price D) When consumers evoke one or more of these frames of reference, their perceived price can vary from the stated price. 1) These “unpleasant surprises”—when perceived price is lower than the stated price—can have a greater impact on purchase. 2) Consumer expectations also play a key role in price response. Price-Quality Inferences A) Many consumers use price as an indicator of quality. B) Some companies adopt exclusivity and scarcity to justify premium prices. Price Endings A) Many sellers believe that prices should end in an odd number. B) Research has shown that consumers tend to process prices in a “left-to-right” manner rather than by rounding.

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C) Prices that end with a 0 or 5 are also popular and are thought to be easier for consumers to process and retrieve from memory. D) Pricing cues like “sale” signs and prices that end in a 9 are less effective the more they are employed. SETTING THE PRICE A firm must set a price for the first time when it develops a new product, when it introduces its regular product into a new distribution channel or geographic area, and when it enters bids on new contract work. A) The firm must decide where to position its product on quality and price. B) Most marketers have 3 to 5 price points or tiers. C) The firm has to consider many factors in setting its pricing policy. 1) Six-step procedure i.

Selecting the pricing objective

ii.

Determining demand

iii.

Estimating costs

iv.

Analyzing competitors’ costs, prices, and offers

v.

Selecting a pricing method

vi.

Selecting the final price

Step 1: Selecting the Pricing Objective The company first decides where it wants to position its market offering. The clearer a firm’s objectives, the easier it is to set price. The five major objectives are: survival, maximum current profit, maximum market share, maximum market skimming, and product-quality leadership. Survival Companies pursue survival as their major objective when they are plagued with overcapacity, intense competition, or changing consumer wants. A) Survival is a short-run objective. 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 Some companies want to maximize their market share. They believe that a higher sales volume will lead to lower unit costs and higher long-run profit. A) This practice is called market-penetration pricing. B) The following conditions favor setting a low price: Copyright 2012 Pearson Education

1) The market is highly price-sensitive, and a low price stimulates market growth. 2) Production and distribution costs fall with accumulated production experience. 3) A low price discourages actual and potential competition. Maximum Market Skimming Companies unveiling a new technology favor setting high prices to maximize market skimming. A) This is also called market-skimming pricing, where prices start high and are slowly lowered over time. Product-Quality Leadership A company might aim to be the product-quality leader in the market. A) Many brands strive to be “affordable luxuries”—products or services characterized by high levels of perceived quality, taste, and status with a price just high enough not to be out of consumer’s reach. Other Objectives Nonprofit and public organizations may have other pricing objectives. Whatever the specific objective, businesses that use price as a strategic tool will profit more than those who simply let costs or the market determine their pricing. 1. Partial cost recovery 2. Nonprofit hospital Step 2: Determining Demand Each price will lead to a different level of demand and therefore have a different impact on a company’s marketing objectives. A) The normally inverse relationship between price and demand is captured in a demand curve. Price Sensitivity The demand curve shows the market’s probable purchase quantity at alternative prices. The first step in estimating demand is to understand what affects price sensitivity. A) Generally speaking, customers are most price-sensitive to products that cost a lot or are bought frequently. B) Customers are less price-sensitive to low-cost items or items they buy infrequently. C) They are also less price-sensitive when: a. There are few or no substitutes or competitors b. They do not readily notice the higher price c. They are slow to change their buying habits d. They think the higher prices are justified e. Price is only a small part of the total cost of obtaining, operating, and servicing the product over its lifetime (total cost of ownership—TCO). D) Companies prefer customers who are less price-sensitive. Copyright 2012 Pearson Education

Estimating Demand Curves Most companies attempt to measure their demand curves using several different methods. A) Surveys can explore how many units consumers would buy at different proposed prices. B) Price experiments can vary the prices of different products to see how the change affects sales. C) Statistical analysis of past prices, quantities sold, and other factors can reveal their relationships. These can be: 1) Longitudinal 2) Cross-sectional Price Elasticity of Demand Marketers need to know how responsive or elastic, demand would be to a change in price. A) The higher the elasticity, the greater the volume growth resulting from a 1% price reduction. If demand is elastic, sellers will consider lowering the price. B) Price elasticity depends on the magnitude and direction of the contemplated price change. It may be negligible with a small price change and substantial with a large price change. It may differ for a price cut versus a price increase, and there may be a price indifference band within which price changes have little or no effect. C) Long-run price elasticity may differ from short-run elasticity. Buyers may continue to buy from a current supplier after a price increase but eventually switch suppliers. Here demand is more elastic in the long run than in the short run, or the reverse may happen: Buyers may drop a supplier after a price increase but return later. The distinction between short-run and long-run elasticity means that sellers will not know the total effect of a price change until time passes. Step 3: Estimating Costs Demand sets a ceiling on the price the company can charge for its product. Costs set the floor. Types of Costs and Levels of Production A company’s costs take two forms, fixed and variable. A) Fixed costs (also known as overhead) are costs that do not vary with production or sales revenue. B) Variable costs vary directly with the level of production. C) Total costs consist of the sum of the fixed and variable costs for any given level of production. D) Average cost is the cost per unit at that level of production

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E) Management wants to charge a price that will at least cover the total production costs at a given level of production. F) To price intelligently, management needs to know how its costs vary with different levels of production. G) To estimate the real profitability of dealing with different retailers, the manufacturer needs to use activity-based accounting (ABC). 1) ABC accounting tries to identify the real costs associated with serving each customer. 2) The key to effectively employing ABC is to define and judge “activities” properly. Accumulated Production The decline in the average cost with accumulated production experience is called the experience curve or learning curve. A) Experience-curve pricing carries major risks. 1) Aggressive pricing might give the product a cheap image. 2) The strategy assumes that competitors are weak followers. B) Most experience-curve pricing has focused on manufacturing costs, but all costs, including marketing costs, can be improved on. Target Costing Costs change with production scale and experience. They can also change as a result of a concentrated effort to reduce them through target costing. A) The objective is to bring the final cost projections into the target cost range. Step 4: Analyzing Competitors’ Costs, Prices, and Offers Within the range of possible prices determined by market demand and company costs, the firm must take competitors’ costs, prices, and possible price reactions into account. A) The firm should first consider the nearest competitor’s price. B) The introduction of any price or the change of any existing price can provoke a response from customers, competitors, distributors, suppliers, and even the government. C) How can a firm anticipate a competitor’s reactions? 1) One way is to assume the competitor reacts in the standard way to a price being set or changed. Step 5: Selecting a Pricing Method Given the customers’ demand schedule, the cost function, and competitors’ prices, the company is now ready to select a price. A) Costs set the floor to the price. B) Competitors’ prices and the price of substitutes provide an orienting point. C) Customers’ assessment of unique features establishes the price ceiling. D) There are six price-setting methods: 1) Markup pricing Copyright 2012 Pearson Education

2) Target-return pricing 3) Perceived-value pricing 4) Value pricing 5) Going-rate pricing 6) Auction-type pricing Markup Pricing A) The most elementary pricing method is to add a standard markup to the product’s cost. B) Does the use of standard markups make logical sense? 1) Generally, no. Any pricing method that ignores current demand, perceived value, and competition is not likely to lead to the optimal price. C) Markup pricing remains popular. 1) Sellers can determine costs much more easily than they can estimate demand. 2) By tying the price to cost, sellers simplify the pricing task. 3) Where all firms in the industry use this pricing method, prices tend to be similar. 4) Many people feel that cost-plus pricing is fairer to both buyers and sellers. Target-Return Pricing A) In target-return pricing, the firm determines the price that would yield its target rate of return on investments (ROI). B) Target-return pricing tends to ignore price elasticity and competitors’ prices. Perceived-Value Pricing An increasing number of companies base their price on the customer’s perceived value. They must deliver the value promised by their value proposition, and the customer must perceive this value. A) Perceived value is made up of several characteristics: 1) Buyer’s image of the product performance 2) Channel deliverables 3) The warranty quality 4) Customer support 5) Supplier’s reputation 6) Trustworthiness 7) Esteem The key to perceived-value pricing is to deliver more value than the competitor and to demonstrate this to prospective buyers. Value Pricing

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In recent years, several companies have adopted value pricing: they win loyal customers by charging a fairly low price for a high-quality offering. A) Value pricing is not a matter of simply setting lower prices. B) It is a matter of reengineering the company’s operations to become a low-cost producer without sacrificing quality. C) Lowering prices significantly helps to attract a large number of value-conscious customers. D) An important type of value pricing is everyday low pricing (EDLP) that takes place at the retail level. E) A retailer who holds to an EDLP pricing policy charges a constant low price with little or no price promotions and special sales. F) In high-low pricing, the retailer charges higher prices on an everyday basis but then runs frequent promotions in which prices are temporarily lowered below the EDLP level. G) The two different pricing strategies have been shown to affect consumer price judgments. 1) Deep discounts (EDLP) can lead to lower perceived prices by consumers over time than frequent shallow discounts (high-low) even if the actual averages are the same. I) Some retailers have even based their entire marketing strategy around what could be called extreme everyday low pricing. Going-Rate Pricing In going-rate pricing, the firm bases its price largely on competitor’s prices. A) The firm might charge the same, more, or less than major competitor(s). B) Going-rate pricing is quite popular where costs are difficult to measure or competitive response is uncertain. Auction-type pricing A) Auction-type pricing is growing more popular, especially with the growth of the Internet. B) There are three types of auction-type pricing: 1) English auctions (ascending bids) 2) Dutch auctions (descending bids) 3) Sealed-bid auctions Step 6: Selecting the Final Price Pricing methods narrow the range from which the company must select its final price. In selecting the price, the company must consider additional factors, including the impact of other marketing activities, company pricing policies, gain-and-risk sharing pricing, and the impact of price on other parties. Copyright 2012 Pearson Education

Impact of Other Marketing Activities The final price must take into account the brand’s quality and advertising relative to the competition. A) Farris and Reibstein’s findings suggest that price is not as important as quality and other benefits in the market offering. Marketing Insight: Stealth price increase Companies trying to figure out how to increase revenue without really increasing prices are increasingly charging additional fees for what had once been free features/services. Company Pricing Policies The price must be consistent with company pricing policies. A) Many companies set up a pricing department to develop policies and establish or approve pricing decisions. 1) The aim is to ensure that salespeople quote prices that are reasonable to customers, and 2) Profitable to the company. Gain-and-Risk Sharing Pricing Buyers may resist accepting a seller’s proposal because of a high-perceived level of risk. A) The seller has the option of offering to absorb part or all of the risk if he does not deliver the full promised value. Impact of Price on Other Parties Management must also consider the reactions of other parties to the contemplated price: A) How will distributors and dealers feel about it? B) Will the sales force be willing to sell at that price? C) How will competitors react? D) Will suppliers raise their prices when they see the company’s price? E) Will the government intervene and prevent this price from being charged? F) Marketers need to know the laws regulating pricing in the United States. ADAPTING THE PRICE Companies usually do not set a single price but rather develop a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, delivery frequency, guarantees, service contracts, and other factors.

Geographical Pricing (Cash, Countertrade, Barter) A) In geographical pricing, the company decides how to price its products to different customers in different locations and countries.

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B) Another question is how to get paid. This issue is critical when buyers lack sufficient hard currency to pay for their purchases. Many buyers want to offer other items in payment, a practice known as countertrade. C) Barter. The buyer and seller directly exchange goods, with no money and no third party involved. D) Compensation deal. The seller receives some percentage of the payment in cash and the rest in products. A British aircraft manufacturer sold planes to Brazil for 70% cash and the rest in coffee. E) 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. A U.S. chemical company built a plant for an Indian company and accepted partial payment in cash and the remainder in chemicals manufactured at the plant. F) 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. PepsiCo sold its cola syrup to Russia for rubles and agreed to buy Russian vodka at a certain rate for sale in the United States.

Price Discounts and Allowances Most companies will adjust their list price and give discounts and allowances for early payment, volume purchases, and off-season buying (see Table 14.5). Companies must do this carefully or find their profits much lower than planned. A) Discount pricing has become the modus operandi of a surprising number of companies offering both products and services. B) Some product categories tend to self-destruct by always being on sale. C) Discounting can be a useful tool if the company can gain concessions in return. D) Sales management needs to monitor the proportion of customers who are receiving discounts. E) Higher levels of management should conduct a net price analysis to arrive at the “real price” of their offering. Promotional Pricing Companies can use several pricing techniques to stimulate early purchase: A) Loss-leader pricing B) Special-event pricing C) Special customer pricing D) Cash rebates E) Low-interest financing F) Longer payment terms Copyright 2012 Pearson Education

G) Warranties and service contracts H) Psychological discounting Promotional-pricing strategies are often a zero-sum game. Differentiated Pricing Companies often adjust their basic price to accommodate differences in customers, products, locations, and so on. A) Price discrimination occurs when a company sells a product or service at two or more prices that do not reflect a proportional difference in costs. 1) In first-degree price discrimination, the seller charges a separate price to each customer depending on the intensity of his or her demand. 2) In second-degree price discrimination, the seller charges less to buyers who buy a larger volume. 3) In third-degree price discrimination, the seller charges different amounts to different classes of buyers: a. Customer-segment pricing b. Product-form pricing c. Image pricing d. Channel pricing e. Location pricing f. Time pricing B) Yield pricing, and yield management systems are used to offer discounts based upon some criteria. C) The phenomenon of offering different pricing schedules to different consumers is exploding. D) Research shows that constant price variations work best in situations where there is no bond between buyer and seller. E) The tactic most companies favor, however, is to use variable prices as a reward rather than a penalty. F) Some forms of price discrimination are illegal. G) Price discrimination is legal if the seller can prove that its costs are different when selling different volumes or different quantities of the same product to retailers. H) Predatory pricing—selling below cost with the intent of destroying competition—is unlawful. I) For price discrimination to work, certain conditions must exist: 1) The market must be segmentable and the segments must show different intensities of demands. Copyright 2012 Pearson Education

2) Members in the lower-price segment must not be able to resell the product to the higher-price segment. 3) Competitors must not be able to undersell the firm in the higher-price segment. 4) The cost of segmenting and policing the market must not exceed the extra revenue derived from price discrimination. 5) The practice must not breed customer resentment and ill will. 6) The particular form of price discrimination must not be illegal. INITIATING AND RESPONDING TO PRICE CHANGES Companies often face situations when they may need to cut or raise prices. Initiating Price Cuts Several circumstances might lead a firm to cut prices: A) Excess plant capacity B) Companies may initiate a price cut in a drive to dominate the market through lower costs. C) Either the company starts with lower costs or initiates price cuts in hope of gaining market share and lower costs. D) A price-cutting strategy involves possible traps: 1) Low-quality trap 2) Fragile market-share trap 3) Shallow-pockets trap 4) Price-war trap Initiating Price Increases A successful price increase can raise profits considerably. A) A major circumstance provoking price increases is cost inflation. 1) Rising costs unmatched by productivity gains squeeze profit margins and lead companies to regular rounds of price increases. B) Companies often raise their prices by more than the cost increase in anticipation of further inflation or governmental price controls, in a practice called anticipatory pricing. C) Another factor leading to price increase is over-demand. 1) The price can be increased in the following ways: a. Delayed quotation pricing b. Escalator clauses c. Unbundling Copyright 2012 Pearson Education

d. Reduction of discounts D) A company needs to decide whether to raise its price sharply on a one-time basis or to raise it by small amounts several times. 1) Generally, consumers prefer small price increases on a regular basis to sudden, sharp increases. E) In passing on price increases to consumers, the company must avoid looking like a price gouger. Customer memories are long, and they can turn against companies they perceive as price gougers. F) Several techniques help consumers avoid sticker shock and a hostile reaction when prices rise: 1. Sense of fairness must surround any price increase. 2. Customers must be given advance notice so that they can do forward buying or shop around. 3. Sharp price increases need to be explained in understandable terms. 4. Making low-visibility price moves first is also a good technique: a. Eliminating discounts b. Increasing minimum order sizes c. Curtailing production of low-margin products d. Creating new economy brands Given strong consumer resistance, marketers go to great lengths to find alternate approaches that avoid increasing prices when they otherwise would have done so. Here are a few popular ones. 1. Shrinking the amount of product instead of raising the price. (Hershey Foods maintained its candy bar price but trimmed its size. Nestlé maintained its size but raised the price.) 2. Substituting less-expensive materials or ingredients. (Many candy bar companies substituted synthetic chocolate for real chocolate to fight cocoa price increases.) 3. Reducing or removing product features. (Sears engineered down a number of its appliances so they could be priced competitively with those sold in discount stores.) 4. Removing or reducing product services, such as installation or free delivery. 5. Using less-expensive packaging material or larger package sizes. 6. Reducing the number of sizes and models offered. 7. Creating new economy brands. (Jewel food stores introduced 170 generic items selling at 10% to 30% less than national brands.) Responding to Competitor’s Price Changes Copyright 2012 Pearson Education

How should a firm respond to a price cut initiated by a competitor? The best response varies with the situation. A) One way is to assume that the competitor reacts in a set way to price changes. B) The other is to assume that the competitor treats each price change as a fresh challenge and reacts according to self-interests at that time. C) In markets characterized by high product homogeneity, the firm should search for ways to enhance its augmented product. 1) If not it will have to meet the price reduction. D) In non-homogeneous product markets, the firm has more latitude. It needs to consider the following: 1. Why did the competitor change the price? 2. Does the competitor plan to make the price change temporary or permanent? 3. What will happen to the company’s market share and profits if it does not respond? 4. Are other companies going to respond? 5. What are the competitor’s and other firm’s responses likely to be to each possible reaction? E) Market leaders frequently face aggressive price cutting by smaller firms trying to build market share. F) The brand leader can respond in several ways: 1. Maintain price 2. Maintain price and add value 3. Reduce price 4. Increase price and improve quality 5. Launch a low-price fighter line G) The company has to consider the product’s: 1. Stage in the life cycle 2. Importance in the company’s portfolio 3. The competitor’s intentions and resources 4. The market’s price and quality sensitivity 5. The behavior costs of /with volume 6. The company’s alternative opportunities H) An extended analysis of alternatives may not be feasible when the attack occurs. I) It would make better sense to anticipate possible competitors’ price changes and to prepare contingent responses. Copyright 2012 Pearson Education

Marketing Memo: How to fight low-cost rivals The first approach to competing against cut-price players is to differentiate the product or service through various means. Secondly, companies must not use differentiation tactics in isolation; companies must be able to persuade consumers to pay for the additional benefits; companies must first bring costs and benefits in line.

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