MARKETING MANAGEMENT12th edition

14 Developing Pricing

Strategies and Programs

Kotler Keller

14-2

Objectives

How do consumers process and evaluate prices?

How should a company set prices initially for products or services?

How should a company adapt prices to meet varying circumstances and opportunities?

When should a company initiate a price change?

How should a company respond to a competitor’s price challenge?

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Understanding Pricing & Consumer Psychology

Reference Prices

Price-quality inferences

Price endings

Price cues

CONSUMER PSYCHOLOGYCONSUMER PSYCHOLOGY PRICING PERSPECTIVESPRICING PERSPECTIVES

Price is what is Paid Price Does Not Mean Value, but Major Determinant of Buyer’s Choice Pricing Strategies Have Evolved: Barter – Fixed – Meets Competition Practices Vary by Markets and Sellers

Determine costs then take traditional industry margins Failure to revise price to capitalize on market changes Setting price independently of the marketing mix Failure to vary price by product item, market segment,

distribution channels, and purchase occasion

COMMON PRICING MISTAKESCOMMON PRICING MISTAKES

PROGRESSIVE PRICING CONCEPTPROGRESSIVE PRICING CONCEPT

Use Pricing as a Strategic Tool -Use Pricing as a Strategic Tool -

by customizing prices and

offerings based on segment value,

customer value and costs

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Consumer Psychology

“Fair price” Typical price Last price paid Upper-bound price

Lower-bound price Competitor prices Expected future price Usual discounted price

Reference Prices

Price-quality inferences

Price endings

Price cues

Consumers compare current

price with reference prices.

Sellers attempt to manipulate

reference prices to justify price

Where consumers use price as an indication of quality

Important where quality and or status is critical to a buying decision

Influential where information about quality is difficult to get or interpret

Urgency created by emphasizing limited price availability

Buyers’ Perceptions of Current Prices are Influenced by Other Prices

“Left to right” pricing ($299 versus $300) Think left-to-right vs rounding - $200 vs $300 Odd number discount perceptions May convey a bargain Even number value perceptions Enable price even number increases without drop in demand Ending prices with 0 or 5 Easier to process and remember “Sale” written next to price Increases demand of a select few items in a product category Use cues sparingly and selectively, especially where buyer knowledge is limited from

Infrequent purchases, seasonality, new item introductions and product variations

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Steps in Setting Price

Select the price objective

Determine demand

Estimate costs

Analyze competitor price mix

Select pricing method

Select final price

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Step 1:Step 1: Selecting the pricing objectiveSelecting the pricing objective

• Survival – Low prices in answer to over capacity, intense competition, changing demand.– Meet expenses in short term until operating efficiencies improved

• Maximize current profits – Calculate costs at various estimated price-to-volume demand ratios and choose the price point

rendering the highest ROI. • Maximize market share (through market penetration pricing when)

– Market is highly price-sensitive, and a low price stimulates market growth,– Production and distribution costs fall within accumulated production experience, and– Low price discourages actual and potential competition

• Maximize market skimming– New (technology) significant provider sets high(est) possible prices (market bearing maximum)– Many buyers have high demand– Small volume unit costs do not cancel out charging high prices– High prices do not attract more competitors– High price communicates with credibility the image of a superior product

• Establish product quality leadership– Higher relative price to nearest competitor– Reasonable number of buyers with high demand– High price communicates with credibility the image of a superior product with superior features and

performance– Competitive price cutting has limited affect on brand price premium

Businesses that use pricing as a strategic tool will likely profit more than those who let costs or the market govern their price.Manage cost to fit pricing strategy.

Steps in Setting Price

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Step 2: Determining DemandStep 2: Determining Demand (sets the ceiling)

– Price sensitivity = degree of changes in demand relative to changes in price = elasticity of demand

– High price sensitivity = elastic demand = generally high cost products, or products purchased often.– Low price sensitivity = inelastic demand = usually low cost products, items purchased infrequently, or when

price is small part of total solution cost over its lifetime = Total Cost of Ownership (TCO).– To optimize profit opportunity companies must know how

product and customer characteristics influence degrees of price sensitivity and demand elasticity.– Therefore, demand is likely to be less elastic when:

substitutes or competitors are few, higher prices go unnoticed, buying habits change slowly, or buyers

feel higher prices are justified.– “Price indifference bands” may exist where price changes within – a specific range have little or no affect on demand.– Demand elasticity can change over time requiring estimates

to be made for short and long term affects of price changes.

Step Step 3: Estimating Cost3: Estimating Cost (sets the floor)Essential to limit pricing and measure profitabilityTotal cost elements: Fixed (overhead) & Variable. Average based on volumeTotal costs vary with volume levels against capacity and experience curve (learning curve) positioningEffective cost management increases flexibility of pricing strategiesPricing should differ as costs differ by relationship = activity-based cost (ABC) accountingTarget costing starts with a desired price and margin then manages costs to meet

StepStep 4: Analyze Competitor Costs / Prices / 4: Analyze Competitor Costs / Prices / OffersOffers - to determine differentiated values as basis for price positioning

Each price will have a different influence on demand levels and thus ultimately influence the marketing strategy

Steps in Setting Price

PRICE

SENSITIVITY

ESTIMATING

DEMAND CURVES

PRICE

ELASCTICITY

OF DEMAND

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Steps in Setting Price Step 5: Selecting a Pricing MethodStep 5: Selecting a Pricing Method

Markup Pricing• Markup price = unit cost/100% less the markup

percentage

• Unit Cost = variable cost + (fixed cost/unit sales)

• Environment: simplified pricing required from carrying multiple product lines, competitor cost bases are similar: retailers, distributors w/salers.

Target-Return Pricing• Target-return price = unit cost + (desired return X

investment capital)/unit sales

• Environment: required to compensate for assumption of risk and significance of investments = R&D and manufacturing enterprises with differentiated product competitors

• Breakeven volume calculated to determine minimum volume performance requirements (fixed cost / price – variable cost)

Value Pricing• Low end pricing for high end quality, value

conscious buyers – every day low price (EDLP)

• Environment: market leader retailers expanding market share, or process-heavy enterprises with intense competition and service differentiation – low cost producers delivering quality offerings

Perceived-Value Pricing• Price based on establishing a total perceived value

from all source of quantifiable benefits. Quantifies value of all components for a total solution offering (i.e. aggregates cost savings, estimated influence on revenue, value of reliability, service, support, etc = value-in-use price by DuPont)

• Element of a total solution are varied to satisfy price buyers, value buyers and loyal buyers.

• Environment: R&D and manufacturing enterprises with significant differentiation or little competition from new product introductions. Progressive market leaders.

Going-Rate Pricing• Prices set by any competitor in a bulk commodity

market other competitors follow suit.

• Environment: parity in cost basis & fluctuations. Focus on maintaining existing market share.

Auction-Type Pricing • Price established by highest bidder in single

transaction market. English-one seller, many buyers, ascending bids. Dutch-one seller, many buyers or reverse, descending bids. Sealed bid-many sellers, confidential responses.

• Environment: liquidations & price volatile goods.

Three Cs ModelFor Price Setting

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Steps in Setting Price Step 6: Selecting the Final Price - ConsiderationsStep 6: Selecting the Final Price - Considerations

– Psychological Pricing• High prices connote quality where an absence of buyer information is available

• Reference price (thinking): suggested retail or proximity placement to other products can influence price

– Gain-and-Risk-Sharing Pricing: perceptions of risk must be offset by risk protection: warranty/guarantee

– Influence of the Other Marketing Elements – final price must take into account the brand’s quality and advertising relative to competition

• Brands with average relative quality but high relative advertising budgets charged premium prices – buyer comfort with the known versus the unknown

• Brands with high relative quality and high relative advertising budgets obtained the highest prices and visa versa

• The positive relationship between high advertising budgets and high prices held most strongly in the later stages of the product life cycle for market leaders

– Company Pricing Policies• Decision making control (reasonable discounting delegation)

• Management and control over profitability

– Impact of Pricing on Other Parties’ Reaction (consistency, discounting, VPAs)• Customers

• External Channels

• Competition

• Legislation

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Price-Adaptation Strategies Geographical Pricing (Cash, Countertrade, Barter)

• Countertrade• Barter• Compensation deal• Buyback arrangement -Offset

Price Discounts and Allowances• Cash or Payment discounts 2%/10th prox• Volume price discounts (VPAs)• Functional Discount (inventory reporting)• Seasonal Discounts (out of season)• Allowances (payment for program participation)

Promotional Pricing

• Loss-leader pricing

• Special-event pricing

• Cash rebates

• Low-interest financing

• Longer payment terms

• Warranties and service contracts

• Psychological discounting

Differentiated Pricing (same cost)

– Customer segment pricing (age group)

– Product-form pricing (capacity)

– Image pricing (multi-brand same cost)

– Channel pricing (source of purchase)

– Location pricing (gas stations)

– Time pricing (seasonal)

– Yield pricing-move expiration date items

Product-mix pricing (price setting logic modified when item is part of a product mix)

– Product-Line Pricing (item to segment)– Optional-Feature Pricing– Captive-Product Pricing - Captive products (essential supplies / enhancements)– Two-Part Pricing (fixed & variable usage fee)– By-Product Pricing (waste products with value)– Product-Bundling Pricing

• Pure bundling• Mixed bundling (unbundable – premium cost)

Pricing variations relative to price setting methodologies occur because of differing market geographies, segments, business practices, and buyer expectations.

International Business to Business

Domestic Business To Business

Domestic ConsumerCommodity

Domestic ConsumerCommodity

Domestic Business To Business and ConsumerCommodity

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Initiating and Responding to Price Changes

• Initiating Price Cuts

– Drive to dominate the market through lower costs

– Low quality trap

– Fragile-market-share trap

– Shallow-pockets trap

• Initiating Price Increases– Cost inflation– Anticipatory pricing– Overdemand– Delayed quotation pricing– Escalator clauses– Unbundling– Reduction of discounts

• Companies can also respond to higher costs or overhead without raising prices by:

– Shrinking the amount of product instead of raising the price– Substituting less expensive materials or ingredients– Reducing or removing product features– Removing or reducing product services, such as installation or

free delivery– Using less expensive packaging material or larger package sizes– Reducing the number of sizes and models offered– Creating new economy brands

• Reactions to Price Changes– Customer Reactions– Competitor Reactions

• Responding to Competitors’ Price Changes• Maintain price• Maintain price and add value• Reduce price• Increase price and improve quality• Launch a low-price fighter line

A function of changing market conditions, competitive initiatives, operationalexpense-to-revenue management (economies of scale), marketing mix effectiveness

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Figure 14.7 Price-Reaction Program for Meeting Competitor’s Price Cut