Final Paper due Midnight Tuesday 8 pages/Send handshakes and will review profiles

Learning Objectives

After studying this chapter, you should be able to:

• Give examples of how buyer psychology influences pricing strategy.

• Explain why a segmented price strategy is worth considering, despite its complexity.

• Describe four inputs to the strategic planning process for pricing decisions.

• Explain the three objectives of sales promotions.

• Summarize three challenges to developing effective pricing strategies.

Frans Lemmens/SuperStock5

The Marketing Mix: Price

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CHAPTER 5Section 5.1 Pricing Basics

Introduction

“Price” is a quantifiable way of measuring the value customers place on an offer-ing. Marketers must understand the relationship of price to value, as value reflects—and affects—the brand image of the offering and the company selling it. This chapter presents concepts related to price, including how promotional enhance- ments affect potential customers’ perception of value.

Price plays two important roles in the marketing mix—it influences how much of an offer- ing will sell and how much profit the sale will generate for the seller. There’s no point in pricing an offering so low that, as the old joke goes, “we lose money on every sale but make it up on the volume.” On the other hand, there’s no point in pricing an offering so high that no one will buy.

Between those two boundaries lies every company’s pricing strategy.

5.1 Pricing Basics

What is a price, exactly? The American Marketing Association defines price as “the formal ratio that indicates the quantities of money, goods, or services needed to acquire a given quantity of goods or services” (2011). At its simplest, price might be described as what a customer has to give up in order to get what he wants to buy. That customer’s sacrifice might consist of money, time, and/or effort.

Developing a pricing strategy is a requirement for every single business that brings an offering to market. (A note about terms: offering is used throughout this chapter when the unit for sale may be either a product or service. Since most of the principles of pricing apply equally to goods and services, the use of offering prevents unnecessary wordiness.)

Failure to price appropriately can rob a business of its competitive edge or starve it by fail- ing to generate sufficient revenue to cover costs. The fact that pricing strategy is complex is reflected in the many terms used for “price.”

Contemplate the number of ways we refer to prices by matching the terms in Table 5.1 with the offering they purchase.

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CHAPTER 5Section 5.1 Pricing Basics

Table 5.1: Many ways to say “price”

Offerings Terms

Sandwich Rent

Credit card Price

Lawyer Interest

Service club Fee

Bus trip Fare

Apartment Dues

Instructions: Match the terms in Table 5.1 with the offering they purchase.

Why so many names for essen- tially the same thing—money exchanged for ownership or use? Because purchase exchanges happen in so many aspects of our culture.

In many cases a price is accom- panied by adjustments that raise or lower it—incentives, allow- ances, and/or extra fees. The amount a buyer will actually pay for an offering is seldom represented simply by the price listed for it.

Consider tuition for education (yet another name for a price). A school publishes its tuition structure. The institution may offer scholarships and other financial aid that reduces that price. It may charge special activity fees that raise that price. It may charge interest to students who opt to pay over time. All those factors affect the price of a semester’s coursework.

If you chose to pursue your education online, you participated as a buyer in the exchange of a quantity of money (tuition) to acquire a given quantity of services (education) from the seller, to paraphrase our definition of price. Interest in distance learning is booming as more people understand the cost savings and the convenience of taking a course from anywhere, and more people have the equipment and online skills to take advantage of those benefits.

Online education is a high‑demand product because it’s convenient and relatively low cost. However, the price is elastic, meaning that if the cost increased, students might consider an alternative.

Serge Kozak/Corbis

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CHAPTER 5Section 5.1 Pricing Basics

Table 5.2: Many ways to say “price” answers

Offerings Terms

Sandwich Price

Credit card Interest

Lawyer Fee

Service club Dues

Bus trip Fare

Apartment Rent

“Price” goes by many names in daily life.

Price and the Marketing Mix The marketing mix, as you have learned in previous chapters, consists of the four p’s of Product, Place, Price, and Promotion. Price can be led or driven by the other four p’s of the marketing mix but cannot be divorced from them. Which of the four will lead devel- opment of the marketing mix depends on the particulars of a company’s situation, target market, and objectives.

As you learned in Chapter 1, the Customer Value Equation (the relationship between per- ceived benefits and the sacrifice required to get those benefits) is dynamic. As perceived ben- efits increase, value increases; so does the customer’s estima- tion of a fair price for those ben- efits. This illustrates how a pric- ing strategy interacts with other aspects of the marketing mix.

Factors affecting the price a company charges for its offer- ings include customer expec- tations, competitors’ pricing strategies, and the brand image a company has chosen to proj- ect, since price reinforces brand identity. A luxury offering can- not be priced below a certain

amount and maintain its luxury aura, nor can a bargain offering be priced above a cer- tain point and still maintain its value positioning. Similarly, customer expectations and

The brand image a company selects affects the price of its merchandise since price reinforces brand identity. A luxury offering cannot be bargain‑priced and still maintain its high‑end positioning.

Weng lei—Imaginechina/Associated Press

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CHAPTER 5Section 5.1 Pricing Basics

competitors’ prices determine a range outside of which a price fails to be perceived as a good value.

Customers’ Expectations and Pricing Strategy Consumers must assess the value they’ll place on an offering, which means estimating what service it will render. Does it fill a basic need or something less urgent? This is the realm of psychology, where motivation, belief, and perception come into play. Let’s look at how the psychological factors influencing buyers’ purchase behavior shapes sellers’ pricing decisions.

The entire purchase situation affects consumers’ perception of value. How products are displayed, what items are nearby for comparison, how helpful the sales staff is, how attractive the store seems—all of these affect consumer perception and, thus, expectations about prices. Moreover, consumers are prone to perceive the situation inaccurately and to react to their inaccurate evaluation of the situation. Fortunately, the psychology of price perception and assignment of value has been well-researched (Nagle & Holden, 1995). What does that research tell us?

First, marketers should be aware of reference pricing—the concept that consumers hold reference points in mind regarding the expected price of many offerings. Whether remem- bered, researched, or inferred from the buying situation, the reference price represents “a fair price” in the consumer’s mind. The reference price is often a price range, the endpoints of which bracket the price points within which the price perceived as fair will fall. The width of that price range held in the consumer’s mind affects his or her judgment of the attractiveness of a posted price. Changes in context around the offering for sale can bring about changes in the price range evoked in consumers’ minds and thus change percep- tions of the attractiveness of a specific price (Janiszewski & Lichtenstein, 1999).

Customers typically know the prices of items they buy frequently. Their reference price ranges on those items act as signposts that signal a store’s prices in general (Anderson & Simester, 2003). If a store charges more than expected for Coca-Cola, for example, a con- sumer is likely to assume that all items in the store are more expensive than they should be. Most people lack the time and inclination to research stores and compare brands to be sure they are getting the best deal. Perceptual cues such as sale signs and prices ending in 9 are surprisingly effective in influencing consumers’ beliefs about prices. Reference pricing, signposts, and perceptual cues are all factors in consumers’ assessment of price and value.

Other factors that influence perceptions of price include promotions, such as “buy one, get one free” offers that invoke mental math leading to a favorable assessment of the posted price, and marketing that links a specific purchase with a social cause or issue.

Finally, marketers must recognize potential buyers’ resistance to change. When a pur- chase will require buyers to spend on additional goods or services to gain its full value, they hesitate. This spending, termed switching costs, can take several forms: Opportunity, implementation, and conversion can each carry costs not included in the offering’s price, but placing a burden on the buyer. For example, switching software in an office might require spending on employee training or conversion of existing template documents. A

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CHAPTER 5Section 5.1 Pricing Basics

member of an airline’s frequent flyer program considering a switch to another will have to weigh the opportunity cost involved: Invariably the new program will bring some addi- tional benefits, but the flyer will have to surrender perks of his or her previous program.

Companies can respond to, but not change, how consumers’ minds work. Buyer psychol- ogy must be taken into account as marketers develop a strategic marketing mix. Pricing decisions will reflect this.

Field Trip 5.1: Qwerty Versus Dvorak Keyboards

The traditional “qwerty” keyboard and alternatives promising increased productivity for typists pres‑ ent an example of switching cost. The investment in training in “qwerty” typing must be replicated to switch to a more efficient alternative, as discussed in this post on the “Freakonomics” blog.

http://www.freakonomics.com/2007/05/30/qwerty-vs-dvorak/

Elasticity of Demand As profound an impact on pricing as customers’ expectations is the concept economists refer to as the Law of Supply and Demand. This economic principle states that, “all other factors remaining equal, the higher the price of a good, the less people will demand that good” (Investopedia.com, 2011).

Supply and demand represent the amount of a product sellers make available (supply) and the amount buyers want to purchase (demand). When supply exceeds demand, buy- ers have greater control over the price suppliers can charge for an offering. When demand exceeds supply, sellers have greater control over pricing.

Supply and demand curves represent this concept visually. The demand curve almost always slopes downward as price decreases and quantity increases, because consumers will typically buy more of the offering as its price goes down. The supply curve slopes upward as the price increases, because consumers will buy less as the price goes up. This model rests on assumptions that the marketplace follows a perfect competitive model in which no firm has influence over the market price, and that a sufficient supply of buyers and sellers exist with adequate information about product qualities and availability. In this model, the point at which buyer and seller equilibrium meet is their shared equilib- rium point, as shown in Figure 5.1. At this position, the price of an offering generates an equal amount of demand and supply for that offering.

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CHAPTER 5Section 5.1 Pricing Basics

Figure 5.1: Supply and demand curves

Supply and demand can achieve a point of equilibrium.

Adapted from http://www.allbusiness.com/glossaries/supply-demand-curves-supply-equilibrium/4958000-1.html#ixzz1Xs9YQ7tY

Of course, there are many determinants of demand, such as individual tastes and the existence (and price) of substitutes, in addition to the price of an offering. Even so, the model provides a good enough approximation of marketplace behavior that predictions based on the model are useful—one reason it is considered fundamental to pricing strat- egy (Schenk, 2011).

Let’s apply supply and demand curves to higher education: The lower the tuition (price) for campus-based courses, the higher the quantity of those courses students will sign up for. The higher the tuition for those classes, the smaller the quantity those same students can afford, and so the number of course enrollments (sales) will decrease. The existence of substitutes, such as similar courses offered online, affects demand for the campus-based offering.

Price changes affect demand. A product that a buyer perceives as a good value when priced at $50 likely won’t seem such a good value if priced at $100. This introduces the concept of elasticity of demand—the degree to which demand for a product or service varies with its price.

Demand for a product or service is considered highly elastic when a small change in price brings about a large change in sales. Demand for an offering is considered highly inelastic if a big price change has little effect on sales. Every offering falls somewhere between elas- tic and inelastic in the eyes of any given market segment; that elasticity of demand will vary from one segment to the next.

Quantity

P ri

ce

Demand curve Supply curve

Equilibrium price

E q

u ilib

riu m

q u

an tity

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CHAPTER 5Section 5.2 Pricing Strategies

Consider your investment in education. Would an increase by $25 in the tuition you paid for a course change your decision to enroll? If you answered “yes,” your demand is elas- tic—it snapped like a worn-out rubber band in response to a small upward change. If you answered “no,” your demand is inelastic—a price change did not affect your demand because of the high value you place on higher education.

Marketers strive to position offerings so that demand for them becomes more inelastic. Companies selling products with highly elastic demand cannot raise prices, since demand will fall off. They must instead rely on controlling costs to generate profits. Companies selling offerings with inelastic demand have more freedom to charge higher prices and thus generate more profits. Branding can turn even basic commodities into premium- priced offerings. Consider bottled water: While many brands are accepted as interchange- able commodities, some consumers are quite willing to pay for the higher-priced FIJI or Perrier brands.

Where the demand for an offering is highly elastic, consumers experience price sensitiv- ity. They’re sensitive about how much they pay and will turn to lower-priced substitutes if the original item they wanted is too expensive. Marketers must estimate demand and price sensitivity when considering where to set prices. An estimate that misses the mark will hurt revenue.

Each of a company’s offerings might experience a different level of demand, with differ- ing degrees of elasticity and price sensitivity, in relation to different market segments. No wonder developing a pricing strategy is complex!

As has been shown, marketers need to understand the interactivity of pricing strategy with the other P’s of the marketing mix, how customer psychology drives perceptions of pricing, and how elasticity of demand affects their offerings—that is, whether demand will snap (behave elastically) in the face of price changes.

Some ways that buyer psychology affects pricing strategy are reference pricing, sign- posts, and perceptual cues. Also influential are sales promotions and links to social causes, which cast prices in a new context of added value either through quantity of goods received or quality of engagement with the brand and the social or environmental causes in the larger world.

Questions to Consider

What situational factors might influence a marketer to make pricing strategy decisions the driver of marketing mix decisions? Develop your own example scenarios.

5.2 Pricing Strategies

A company’s pricing strategy reflects the sum of its activities aimed at finding a product’s optimum price. Pricing strategy takes into account overall market-ing objectives, consumer demand, product attributes, competitors’ pricing, and

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CHAPTER 5Section 5.2 Pricing Strategies

market and economic trends. The prices consumers encounter in advertising and at the point of sale are just the tip of the iceberg. The company cannot set a price higher or lower than customers expect. Competitors’ pricing also constrains the price range a company can charge and yet remain competitive.

Two overarching questions must be addressed to choose an appropriate pricing strat- egy: whether to emphasize volume or profit, and whether to adopt a fixed or variable approach.

Volume or Profit Maximization? The question of volume or profit maximization represents two different objectives. In the volume maximization approach, the company’s primary objective is to generate as much sales volume (and revenue) as possible. On the other hand, the profit maximiza- tion approach makes the objective to generate the highest net income over time. The main difference between volume maximization and profit maximization is the financial effect. Volume maximization generates cash flow but can reduce profits, because companies can find themselves selling at a loss to generate revenue. Profit maximization requires that all sales maintain acceptable profit margins.

A clear difference between the volume and profit maximization approaches is the time- line in question. Volume maximization is a short-term strategy intended to generate sales volume quickly. This can be effective to build up cash on hand, expand a customer base, attract customers from competitors, or dispose of unwanted inventory. The underlying goal is often to increase market share and reduce costs, resulting in long-term profits.

On the other hand, profit maximization addresses the profit objective directly with a focus on positioning a brand for long-term success. In many cases, profit maximization is the overarching goal but volume maximization takes temporary priority, for example during the launch of a business or near the end of a quarter or fiscal year. Before marketers can establish the pricing strategy that will form the basis for day-to-day decisions, they need deep understanding of overall company strategy.

One Price or Many? The varying price sensitivity among market segments introduces the possibility of charging different prices to different segments. When different market segments have different perceptions of value, a different price can be charged to different customers or at different times. With this variable pricing strategy a company can generate more revenue from market niches willing to pay higher prices and still maintain sales to those placing a lower value on that offering. There are advantages and disadvantages to a variable price strategy.

A fixed pricing strategy, in which the same price is charged to all customers, is easier to administer. Training the customer service staff and accounting for sales is easier, but the rigidity of this policy can seem unfriendly to customers, and revenue opportunities could be lost.

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CHAPTER 5Section 5.2 Pricing Strategies

If a company chooses a fixed price strategy, it must decide whether to occupy the high, average, or low price position. If instead a company chooses a variable price strategy, cer- tain complications ensue—but the promise of greater revenue makes overcoming those complications attractive.

The goal of variable pricing is to ensure that companies are selling the right product to the right consumer at the right price, while steering clear of illegal practices. U.S. law prohib- its price discrimination, defined as the practice of charging different prices to different buyers for goods of like grade or quality.

The norms of specific industries tend to define which companies opt for a variable pricing strategy. The tiered pricing plans common among cell phone carriers are an example of a variable pricing strategy designed to avoid problems with overburdening existing net- works while allowing carriers to make money from mobile data and applications, rather than just voice minutes (Wortham, 2011). Tiered pricing is legal because each tier repre- sents a bundle of different service options for calls, text messaging, and data usage.

Variable pricing is accepted in many parts of the world. Haggling is an ancient form of variable pricing. North Americans tend to expect market- ers to practice a one-price policy, representing the fundamental fairness of a democracy. A compa- ny’s strategic decision to pursue a fixed or vari- able pricing strategy must take this into account.

Pricing Strategies for Every Situation Having chosen an objective of either volume or profit maximization, and a one-price or variable pricing approach, it falls to marketers to fine-tune their choice of pricing strategy to fit the specifics of their situation.

Marketers in service industries can adopt peak- load pricing to counter the perishability of their offerings. Similarly, marketers can adopt yield management to exploit timing to generate sales while managing a fixed, perishable capacity. Most people have had experience with airlines’ use of price changes to profitably manage the fit of a fixed supply to a varying demand. Air- lines change prices frequently—even minute-by- minute—depending on their supply of seats and demand for them.

Dell Computers was one of the first to adopt the co‑creation model, offering a base price for specific features and then encouraging customers to customize features to create a unique product.

Associated Press

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CHAPTER 5Section 5.2 Pricing Strategies

Marketers can adopt a co-creation model, in which customers bundle options to design their own offerings that suit their individual ideas of value. A company can participate in a dynamic pricing model, in which the buyer collaborates with the seller, allowing retailers to offset the threat created by price comparison, which drives prices down and narrows profit margins (Swabey, 2007).

E-commerce facilitates dynamic pricing, which gave rise to the “Name Your Own Price” (NYOP) variation popularized by Priceline.com. Unlike the traditional seller-driven pric- ing model, in which the seller prices the goods, leaving the buyer to “take it or leave it,” the NYOP approach is buyer-driven. In response, sellers opt for opaque exchanges, stra- tegically withholding information from customers who may not know the exact features of their purchase at the point of payment. Processing is fast, and competition among cus- tomers is minimized since no one knows what anyone else is paying. NYOP gives firms more leverage in inventory control and pricing to different segments. But in the end, it may be a double-edged sword, making it difficult to predict profit margins and increasing buyer-driven sales by cannibalizing seller-driven channels (Huang & Sosic, 2011).

Marketers can signal positioning of their brands through pricing, choosing a high, aver- age, or low price point in relation to competitors, as mentioned earlier. Skim pricing is defined by setting prices high to attract higher-income groups for luxury or status goods. Neutral pricing is defined by matching prices of the general market, a decision that shifts comparison to other features of an offering. Penetration pricing is defined by keeping prices low in comparison to competitors’ and widely promoting an offering, to quickly achieve more sales to more buyers. Opting for a penetration price works best when the seller intends to maintain consistency of pricing, forgoing use of sales events or other discounts that would lower revenue even further. Walmart long held this position with its strategy of promising “everyday low pricing” with few discount sales promotions (Perner, 2008).

Field Trip 5.2: Walmart’s Everyday Low Pricing

Follow this link to an article on Walmart Watch, evaluating the company’s relaunch of an everyday low pricing strategy in 2011.

http://walmartwatch.org/blog/archives/walmart-re-launches-edlp-strategy-again/

Penetration pricing de-emphasizes market segments. It works where buyers are price- sensitive and markets are large enough that thin profit margins are sustainable, but it is highly vulnerable to competitors who match low prices (Nagel & Holden, 1995). This and other pricing strategies are shown in the graph in Figure 5.2.

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CHAPTER 5Section 5.2 Pricing Strategies

Figure 5.2: Pricing strategies that signal economic value

Price is a signal of economic value.

Adapted from Nagel and Holden, 1995

Medium

Sk im

mi ng

Ne utr

al

Pe ne

tra tio

n

Economic value

R el

at iv

e p

ri ce

Low High

M od

er at

e Lo

w V

er y

lo w

H ig

h V

er y

hi gh

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CHAPTER 5Section 5.2 Pricing Strategies

Table 5.3 summarizes pricing strategies discussed in this chapter.

Table 5.3: Pricing strategies and objectives

Definition Example Use

Peak load Charging higher prices during periods of rising demand

Power utilities charge more for power during high‑demand periods to encourage customers to use services during non‑peak hours.

Counter the perishability of a service offering; viable only when few competitors exist.

Yield management Strategic control of inventory to maximize yield or profits from a fixed, perishable resource

Restaurants charge less during off-peak periods for the same package of seat, menu, and service.

Counter the perishability of a service offering; reduce the strain on a fixed- capacity infrastructure.

Co-creation Allowing customers to select from options to design customized offerings

Dell Computers offers a base price for specific features, encouraging customers to add or subtract features to create a unique product.

Meet customers’ desire to partner with the companies they buy from and to customize the value they receive.

Dynamic pricing Buyer collaborates with seller to establish the price, accepting trade- offs in exchange for favorable pricing.

Mobile phone carriers, electrical utilities, Internet domain names, auto insurance

Offset threat created by buyers’ knowledge of competitors’ pricing.

Opaque exchanges Seller withholds information from customers about exact features of their purchase until transaction is completed.

Name Your Own Price strategy offered by Priceline.com

Give firms leverage in inventory control and pricing to different segments.

Brand leadership (skim) Setting prices high in comparison to competitors

Luxury goods Attract higher-income groups.

Neutral Matching prices of the general market

Arts organizations such as symphony orchestras

Shift emphasis to competing on other aspects than price.

Penetration Keeping prices low in comparison to competitors’

Walmart’s “Everyday Low Prices”

De‑emphasize market segments.

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CHAPTER 5Section 5.2 Pricing Strategies

In a marketing era that values long-term customer relationships, both organizational buy- ers and consumers have come to expect a degree of flexibility in pricing. While all the pricing strategies discussed are viable choices, those that allow for customer negotiations are gaining in importance.

Segmented Pricing An appropriate response for companies wanting to pursue a variable pricing strategy while staying on the right side of the law is segmented pricing, a tactic for separating markets and matching differentiated offerings to them.

A segmented pricing strategy is a natural extension of a company’s market segmentation strategy. Segmentation can be an effective response to variations in segment price sensi- tivity and a useful tool for differentiation from competitors. In industries with high fixed costs, such as cell phone carriers and power utilities, segmented pricing is often essential (Nagle & Holden, 1995). Without it, the companies could never cover their costs and still serve all the customers who need their services.

Why don’t all companies implement a segmented pricing strategy? Certain factors work against it:

• Customers don’t self-identify themselves into segments; this puts the burden on the seller to identify segments with differing demand.

• The costs of managing the segmentation program can’t be higher than the extra revenue earned by the differences in prices.

• Intermediaries can undermine the strategy by figuring out how to buy low and sell high.

• A poorly designed segmented price strategy can violate federal antitrust laws.

An extremely important factor is that whatever price a customer is charged for the value he or she receives, that price should reflect a real difference in value from similar offerings purchased at other price points by other customers. Otherwise, the company risks charges of illegal price discrimination.

There is also the possibility of an outcry of consumer resentment if prices charged to dif- ferent segments do not reflect a real difference in value. This happened when Adidas charged more for rugby team shirts in the team’s home country of New Zealand than it charged for the same shirts in other countries.

In summer 2011, when New Zealand’s hugely popular rugby team the All Blacks made it to the Rugby World Cup, national pride soared—and so did demand for the official team jersey. New Zealand fans went into a frenzy when they discovered shirts were being sold online in the United States and Britain for about half the local price in New Zealand. Local news outlets ran with the story. Anger escalated when it was reported that Adidas told online retailers selling internationally to remove New Zealand from the available delivery options. The Adidas brand image suffered as a result, to the extent that corporate sponsorship events were canceled and branding removed from company vehicles after staff members were publicly harassed (Hutchison, 2011). In a Marketing 3.0 world of con- nected consumers, discriminatory pricing policies will be met with consumer protest, if not a legal challenge.

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CHAPTER 5Section 5.2 Pricing Strategies

A segmented pricing strategy benefits consumers. It spurs competitive innovation when companies develop improvements that different market niches will value, thus allowing them to charge more profitable prices. Without segmented pricing, some small market niches’ demands would more frequently go unmet.

Some segmented pricing tactics that have proven effective (and legal) include varying the price by customer segment, demand elasticity, price sensitivity, product version, season- ality, geography, and volume purchase. Other tactics include product bundling, in which

the items combined increase the value for a specific buyer segment, such as an orchestra bundling concert tickets into a season package or an airline offering hotel and rental car bundled with the purchase of a flight.

In conclusion, a pricing strategy must reflect overall corporate objectives regarding volume and profitability over both short and long time frames. Market- ers may support the objective by offering a fixed price to all cus- tomers or a price that varies by market segment. A number of pricing strategies serve different purposes and situations; those that allow customers to partici- pate in establishing the price are becoming more important. A

segmented pricing strategy holds potential to yield the most revenue, as each customer pays what he or she perceives as a fair price for the value received. However, this is the most difficult strategy to implement.

In the end, successfully responding to the economics of pricing relies on marketers who must find product advantages that create sustainable competitive differentiation. This is the only way to avoid competing solely on price.

Consumer resentment can result when the price charged to different segments doesn’t reflect an actual difference in value. Adidas learned this when it charged more for team shirts in one country than another.

Associated Press

Questions to Consider

Choose one product category and describe how a segmented pricing tactic could be used to increase revenue while steering clear of laws against price discrimination.

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CHAPTER 5Section 5.3 Inputs to the Pricing Decision

5.3 Inputs to the Pricing Decision

As stated earlier in this chapter, the pricing strategy decision is driven by situ-ational factors, including customers’ expectations, competitors’ moves, and the company’s brand position. Strategic planning leads to pricing decisions designed to achieve overall company objectives, as well as specific marketing objectives.

Production costs set the “floor” price, below which sales cannot translate to profits. Con- sumers’ perceptions create the “ceiling” price, above which there will be no demand for the offering given consumers’ estimation of its value. In between those two points, inter- nal and external factors exert their influence on what the price strategy will be.

Companies select a methodology by which to calculate price ranges that will meet their volume or profit maximization goals, choosing from the following:

• Cost-plus: Adding a standard markup to unit cost derived by adding fixed and variable costs of production;

• Target profit: Calculating breakeven costs of making and marketing a product, selecting a price to make a target profit above that cost;

• Competition-based: Setting prices based on competitors’ prices for similar offerings;

• Value-based: Using buyers’ perception of the Customer Value Equation to design an offering that can be sold profitably at a price buyers recognize as fair; and

• Markup: Adding a constant percentage to the cost paid for an item to arrive at its selling price.

Increasingly, companies are turning to the value-based pricing method to ensure they are offering good value at a fair price (Kotler, 2006). The value-based method offers the most potential for competing on real points of difference among offerings, thus escaping competition on price alone. By estimating the economic value to a customer in order to set prices, marketers gain fundamental insight to inform all decisions of the marketing mix. Positioning becomes the driver rather than price competition.

Strategic Planning for Pricing Decisions Pricing decisions have far-reaching implications for the operations of an organization. These decisions must be based on sound strategy that takes into account four influential factors:

1. Costs, 2. Target market, 3. Environment, and 4. Differentiation strategy.

To arrive at a sound strategy, marketers apply the strategic planning process to pricing, just as they do to arrive at strategies for the other areas of the marketing mix. Figure 5.3 shows the four influencing factors as inputs to the strategic planning process (which is discussed in more detail in Chapter 9).

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CHAPTER 5Section 5.3 Inputs to the Pricing Decision

Figure 5.3: Inputs and processes of effective price strategy

Costs Target market Environment Differentiation

Situation analysis

Objectives

Goals

Tactics

Pricing strategy

Four factors are inputs to the strategic planning process by which marketers arrive at a pricing strategy.

Strategic planning cannot be done in a vacuum. The process must begin with situation analysis so that resulting plans take into account internal and external factors. Inter- nal factors, such as the cost to produce the product, are relevant, as is the influence of strategies for target marketing and competitive differentiation. Meanwhile, the environ- ment includes an extremely important external factor affecting pricing: the psychology of buyers.

Costs A company’s financial managers as well as its marketers take a great interest in this input to the pricing decision, but from different perspectives. While the financial manager is pri- marily interested in how high prices can be set to achieve profit objectives, the marketer is more interested in how low prices can go, to achieve sales volume objectives. The two must collaborate to reach a coherent pricing strategy (Nagle & Holden, 1995).

The key to determining the price at which sales will be profitable is the breakeven anal- ysis, which calculates the point at which a company’s total sales revenues equal total expenses. This is the lower limit a pricing strategy must deliver in sales. The analysis is essentially a “what-if” exercise that projects the breakeven point given specific assump- tions about sales volume and pricing.

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CHAPTER 5Section 5.3 Inputs to the Pricing Decision

The breakeven analysis depends on four key assumptions:

1. The price received per unit sold; 2. The incremental cost, or variable cost, on average, of each unit sold; 3. Monthly fixed costs, those associated with normal operations of the business; and 4. Sales volume (how many units will be sold).

Fixed costs remain largely the same despite changes in production volume, such as rent, insurance, and new product development, while fluctuate with production volume, for example process materials or sales commissions.

Managers use the estimate of sales volume to calculate the variable cost total and the total sales revenue (price multiplied by units sold). Estimating a specific sales volume allows them to perform the following calculation:

Breakeven point (in dollars) = Total fixed cost 1 – Cost per unit price

Managers then vary their assumptions to see how changes in the estimate of costs, sales, or price per unit will change the breakeven point, as illustrated in Figure 5.4.

Figure 5.4: Breakeven point

Estimate costs, sales, and price per unit to establish a breakeven point.

Output

B

Break-even point

ProfitLoss

O

P

Q

C

A

Variable costs

Fixed costs



Costs

Income

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CHAPTER 5Section 5.3 Inputs to the Pricing Decision

Helpful as it is, this breakeven analysis method showing the effect of changing output on revenue hasn’t taken into consideration consumer demand. Therefore, managers will typically modify this approach by creating estimates of the number of units consumers are likely to purchase at each of a series of retail prices, taking into account elasticity of demand and potential buyers’ price sensitivity. These data can then be superimposed onto a breakeven chart to reveal feasible prices, as shown in Figure 5.5. With this calcu- lation, both financial managers and marketers have solid data to inform a value-based pricing strategy.

Figure 5.5: Breakeven trade-off between price and sales volume

Quantity

R ev

en u

e an

d c

o st

s

Quantity

R ev

en u

e an

d c

o st

s

Revenue at $15 per unit

TR1 ($15)

TR2 ($10)

TR3 ($9) TR4 ($8)

TR5 ($7)

Breakeven points

Revenue at $10 per unit Revenue at $9 per unit

Revenue at $8 per unit Revenue at $7 per unit

Total variable cost $5 per unit

Total fixed cost $40,000

Demand curve

Total fixed cost

Total cost Total cost

To arrive at a value-based price strategy, marketers estimate demand at various price points, taking into account elasticity of demand and buyers’ price sensitivity.

Kurtz, p. 688

Breakeven analysis will reveal feasible prices at which sales will generate revenue, based on the seller’s fixed and variable costs and the nature of buyer demand. It’s important to note that additional factors affect price and must be accounted for. Another tool, price waterfall analysis, is used to model the actual profit the firm retains on a sale at a specific price after transactional costs that impact price, such as discounts and other incentives, have been applied.

The price waterfall begins with the list price or manufacturer’s suggested retail price (MSRP), the price a company officially displays to buyers. Significant sums can leak away as buyers receive promotional “give-backs” such as free shipping, volume discounts, and bonuses for paying cash. That initial price is gradually nibbled down through transac- tional costs to arrive at the final pocket price the seller actually receives. The pocket price has to cover costs, so it must reflect the breakeven point.

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CHAPTER 5Section 5.3 Inputs to the Pricing Decision

In a complex distribution channel, nibbling might occur at multiple steps along the way from manufacturer to end consumer, creating a significant “hole in the pocket.” Figure 5.6 illustrates a price waterfall for automobiles sold by General Motors.

Figure 5.6: Price waterfall

MSRP Invoice price Pocket price

Promotional incentives

Cash rebates

Standard dealer

discounts

The price waterfall graphically represents how a list price is gradually reduced to a pocket price.

Adapted from: http://www.wiglafjournal.com/pricing/2006/12/gm-may-be-learning-price-disciplinegrowing-margins-while-lowering- prices-by-tilting-the-price-waterfall-vector/

Target Market For this input to the pricing decision, customers’ perception of value, the elasticity of their demand, and their price sensitivity (which determines the maximum price feasible to charge) come into play.

Marketers estimate the price sensitivity of buyers in the target market(s) using both the economic and psychological factors affecting buyers. Blending these factors, marketers can estimate a product’s economic value, defined as the reference price the buyer assigns to the features that differentiate an offering from the alternatives available at the reference price. The differentiating value can include negatives as well as positives. Looked at this way, the economic value is the price that well-informed shoppers, seeking the offering best suited to their needs, would consider a good value.

However, not all buyers make purchase decisions exactly as economic value would pre- dict, because the expenditure is small (not worth the bother of evaluation), someone else is paying, or a desire to impress others causes the buyer to choose a higher-priced

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CHAPTER 5Section 5.3 Inputs to the Pricing Decision

alternative. Again, understanding distinct market niches will help marketers anticipate responses to various price scenarios, taking into account economic value. Given the argu- ments in favor of a segmented price strategy, understanding the target market means understanding many distinct market niches, each affected by economic and psychological factors in different ways.

The target market input to pricing strategy emphasizes creating lasting relationships with customers by delivering a satisfactory Customer Value Equation.

Environment This input to the pricing decision covers the external factors influencing a company’s pric- ing decisions—economic conditions, intermediaries, competitors, and social concerns.

Economic factors such as recession, inflation, and changes in interest rates affect the macro-environment—competitors and consumers all feel the same pressures. A price increase may be needed to cover costs of production hurt by negative economic trends, and yet, prospective buyers—also feeling the pinch—may be more price-sensitive than ever. Competitors and channel partners may react to economic forces with their own price adjustments. Both consumers and business leaders increasingly place expectations of social sustainability on companies, creating the triple bottom line of responsibility for social and environmental impacts as well as financial profitability. Any or all of these fac- tors can alter the assumptions driving a breakeven analysis.

Marketers must consider the nature of the marketplace in which a company competes, taking into account how many and what kind of competitors exist and whether the offer- ings for sale are uniform commodities or highly differentiated offerings. Sellers of undif- ferentiated offerings have little power to increase their price without losing sales volume, unlike sellers of highly differentiated goods or services. And this leads us to the final input to the pricing decision: differentiation strategy.

Differentiation Strategy This input to the pricing decision involves an offering’s positioning strategy, which in turn flows from market segmentation and targeting.

In 1980, American economist and Harvard Business School professor Theodore Levitt wrote:

Any product can, in principle, be distinguished from the commodity mass. The key is recognizing that what buyers purchase is more than just the physical product or particular service exchanged. They buy an entire pack- age—including the ease of purchase, terms of credit, reliability of delivery, pleasantness of personal interactions, fairness in handling complaints, and so on—that is called the augmented [enhanced] product. Even when the physical product or service is immutable, the augmented product is invari- ably differentiable. (Levitt, 1980)

Differentiation strategies were covered in Chapter 3. What’s important to realize, in apply- ing that knowledge as an input to pricing decisions, is the tremendous effect that product

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CHAPTER 5Section 5.3 Inputs to the Pricing Decision

strategy has on price—and the effect that price has on product strategy, as it supports product positioning.

Let’s consider one of the ways product strategy affects pricing: product line pricing.

Buyers’ psychological reference pricing comes into play in evaluating individual products in a product line. When items with added features are priced in increments, the cost dif- ference between the products signals quality or feature differences. For example, a line of Black & Decker Dirt Devil hand vacuums begins with a basic model, topped by several more expensive models promising added power and useful accessories at incrementally higher prices.

Sellers naturally want to sell more of the more-expensive items. But buyers will rarely opt for the highest-priced item, not wanting to be seen as ostenta- tious consumers or “easy marks.” A simple response in pricing strategy is to set the price of the most expensive item in the line quite high, in effect ratcheting up the other prices in relation to it, which will thus position them as better values by comparison. As long as the seller’s marketing messages convey quality dif- ferences between the offerings, the strategy delivers perceived value to buyers and profits to the seller.

In conclusion, a company’s strategic planning to determine pricing strategy must consider

four factors. Production costs must be calculated to determine a breakeven point that takes into account fixed and variable costs. The target market’s perception of the prod- uct’s economic value must be understood. External environmental factors will affect the success of any pricing strategy. Aspects of the offering that differentiate it from compet- ing options affect the Customer Value Equation, and so product strategy must also be included in strategic planning to determine pricing.

Strategic planning to determine pricing should include consideration of product line strategy. When these items are priced in increments, the cost difference between products signifies differences in features or quality.

dpa/Corbis

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CHAPTER 5Section 5.4 Adjusting Price Strategically

5.4 Adjusting Price Strategically

So far our discussion of pricing strategy has focused on its role in the marketing mix as an influence on the quantity of an offering that can be expected to sell, and the profit those sales will generate for the seller. Now the discussion moves to the strategies and tactics for changing prices.

About half of all companies change prices once a year or less, but as many as 1 in 10 change prices every month (Kurtz, 2010). Clearly, for most companies pricing strategy is characterized by frequent revisions. Marketers may change their pricing strategy to outmaneuver competitors, or to achieve a shift in potential buyers’ perception of an offer- ing’s value. They may change prices in an attempt to increase sales volume, or to increase profitability at the current sales volume. With so many possible effects, it’s evident that price changes must be addressed strategically.

An increase in posted prices can be positive for a company but can anger current cus- tomers, who perceive a negative shift in the Customer Value Equation when the price increases but nothing else about the offering changes. Price increases can be risky if mar- keters don’t communicate a benefit, or at least a logical need that requires the company to pass on new costs to customers (as with gas price fluctuations). Thus price increases need to be accompanied by strategic marketing communications.

Marketers considering a price decrease need to decide whether the change will be a short- term strategy, lowering the base price for a stated period with a fixed end-date on which prices revert to the original base, or a long-term strategy in which the new pricing strategy becomes permanent.

Reductions from the base price can be part of the permanent pricing strategy. Marketers frequently create policies allowing cash discounts for prompt payment, trade discounts to certain channel partners, and quantity discounts to buyers at specified volume levels.

Field Trip 5.3: Pricing of MP3 Players

Consider the pricing of portable MP3 players in terms of the four inputs to the pricing decision. Taking yourself as a representative of the target market, pick one product on the market and explain what you would tell a marketer about the economic value you place on that product.

Use this site or one like it to research your answer:

http://reviews.cnet.com/mp3-players/

Questions to Consider

Returning to the product category you chose in the previous section, choose one of the factors of cost, target market, environment, or differentiation and describe how it might influence the choice of pric‑ ing strategy for an offering in that category.

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CHAPTER 5Section 5.4 Adjusting Price Strategically

Temporary Price Adjustments For the rest of this discussion on price adjustment, we’ll focus on short-term strategies that decrease prices. Note that these promotions are an integral part of the marketing plan that can contribute to long-term objectives related to product life cycles, corporate growth strategies, or other strategic aims.

Sales promotions are short-term marketing strategies intended to stimulate purchases over a specific time period, by offering a reason to buy in addition to the service rendered by the offering regardless of price. The promotion temporarily shifts the balance of the Customer Value Equation in the buyer’s favor. That shift is intended to influence buyer behavior for the short-term benefit of the seller, for example by encouraging switching from another item to the one promoted, stockpiling of the promoted item, or creating an incremental lift in overall sales.

A sales promotion is just one of many types of promotional campaigns a company can offer. (Promotions are discussed in the next chapter on the final “P” of the marketing mix.) A promotional campaign qualifies as a sales promotion when it involves a decreased price intended to:

• Encourage new customers to try an offering for the first time, • Increase recall of favorable experiences from previous trial or awareness of brand

image, or • Reward customers who have been loyally buying at full price.

Promotional pricing strategies can be used anywhere along the distribution channel—as a pull tactic to encourage consumers to buy, or as a push tactic to encourage distributors to sell, as described in Chapter 4. Consumer-oriented (pull) tactics include the following:

• Samples: Free products distributed in hopes of obtaining future sales. • Refunds: Money returned on presentation of proof of purchase of an offering. • Premiums: Items given free or at reduced cost with purchases of other items. • Coupons: Documents that can be exchanged for a financial discount. • Contests: Prizes given to winners who are drawn from a pool of entrants who

have completed a required task. • Sweepstakes: Prizes given to winners selected by chance from a pool of entrants. • Cash rebates: Money returned on what has already been paid for an offering. • Bonuses: Payment or gift added to what is expected.

Trade-oriented (push) tactics include:

• Trade allowances: Financial incentives to purchase or promote specific offerings. • Sales incentives: Programs that reward intermediaries’ superior performance.

The feature these consumer and trade promotions have in common is that the seller for- goes some portion of the regular price to achieve one of the three objectives of promo- tional pricing.

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CHAPTER 5Section 5.4 Adjusting Price Strategically

A price discount creates urgency to act, which can be very helpful in meeting short-term objectives. After all, pricing is the only “P” in the marketing mix that can be changed quickly.

To be effective, discount promotional periods must be alternated with time periods in which no promotions are in effect. Otherwise, consumers set their reference pricing expec- tations at the sale price. High-low pricing is a strategy by which marketers leverage this tendency of consumers in their favor. The company intentionally sets its regular prices higher than its target prices and then holds sales promotions during which prices are lowered to the target price. This strategy is most effective when consumers in the target market hold a strong belief that discount sales equate with better value-for-price.

An example of a pull promotional price strategy can be found in stores that offered gas discounts to customers in the summer of 2011, when high gas prices added to the misery consumers were already experiencing from the stagnant economy. To stimulate shopping trips some retailers and manufacturers offered discounts on gas purchases, recognizing that high gas prices were keeping consumers from shopping as frequently as in the past. The Publix grocery chain offered $50 gas cards for $40 with a minimum purchase of $25 in other products. Kellogg’s asked shoppers to send in bar codes from certain cereals to receive a $10 gas card. CVS pharmacies gave customers a $10 gas card when they spent $30 on certain items (Clifford, 2011). These gas- discount sales promotions conveyed an “I feel your pain” message more vividly than the other strategy these companies could have chosen— offering deeper discounts on products purchased in the stores. The sellers achieved increased sales volume with their promotional price tactic.

Sales Promotions: Too Good to Be True? Some marketers feel that offering discounts is a flawed strategy, suggesting that frequent sales simply train customers to wait for sales before they buy. While sales can increase recall of brands and remind buyers of past positive experiences, they do not necessarily engage consumers with the brand or build lasting relationships. Custom- ers who get pleasure from hunting down dis- counts will likely go wherever the bargains are.

The tactic of using sales promotions to reward customers who have been loyally buying at full price also has its critics. Some ask, why would a company forgo sales income? Others respond that rewards to loyal customers are justified, pointing out that competitors may be recruiting those cus- tomers with their own sales promotions and that customers appreciate recognition of their loyalty.

Retailers responded to high gas prices during the summer of 2011 with discounts on gas purchases—a promotional price strategy designed to stimulate shopping trips.

Ted Soqui/Corbis

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CHAPTER 5Section 5.4 Adjusting Price Strategically

Results will determine whether the criticism is valid. Sales promotions must be measured to prove their worth as a pricing strategy. It’s important to measure the incremental sales generated by the promotion—not total sales—to find the contribution to ROI from the sales promotion. If the ROI isn’t there—there’s a flaw somewhere in the sales promotion strategy.

Sales Promotions as Business Model In 2007, as the U.S. economy weakened sharply, the demand for luxury goods dropped dramatically—and a new business model emerged online that had sales promotions in its DNA.

Online retailer Gilt Groupe started a members-only site to sell high-end merchandise at deep discounts. That move launched a fast-growing trend: flash sales, featuring designer brands at bargain prices for very limited time periods (Khalid, 2011). Originally intended to unload excess inventory, flash sellers encountered problems in 2011. Reces- sion-affected manufacturers cut back on production, reducing the inventory available to be liquidated. The original flash-site sellers attempted to turn their business model from liquidating inventory toward spotlighting brands, having observed that many buyers who visit flash-sale sites soon buy merchandise from the same brands at full price. The advantage of the flash-sale sites began to rest more on their ability to gather consumer data (by tracking behavior on their sites) and less on the original inventory-management objective (Miller, 2011).

Field Trip 5.4: Flash Sales as Business Model

Search on the terms “flash sale discounting” using your favorite search engine to discover the current state of flash retailing. Is Gilt Groupe still the dominant player?

You could start your research with this article from Ad Age DIGITAL from September 19, 2011:

Think Consumers Are Tired of Deals? Better Think Again

http://adage.com/article/digital/consumers-tired-deals/229862/

The “deal of the day” site Groupon is an example of a business model designed to lever- age consumer interest in sales promotions and social media. The company offers one “groupon” each day in each of the markets it serves. If a certain number of people sign up for the offer, then the deal becomes available to all. This gives the offer a social compo- nent—by forwarding Groupon offers to friends, consumers can increase the likelihood the deal will become available. This reduces risk for retailers too, who can treat the coupons as quantity discounts as well as sale offers. (Groupon makes money by keeping about half the list price of the coupon.) However, participating in a Groupon deal can prove to be an unprofitable prospect for retailers who must use deep discounts to attract customers to a daily deal. Retailers need to carefully calculate how many coupons they can validate and still make money (Carrera, 2011).

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CHAPTER 5Section 5.5 Challenges to Effective Pricing Strategies

5.5 Challenges to Effective Pricing Strategies

Throughout this chapter, we’ve made the case that pricing decisions must be strate-gic to produce results. But certain challenges counter any organization’s efforts to develop and implement effective pricing strategies. Perhaps the most important constraint is the need to stay within the bounds of all appli- cable laws. Beyond the rule of law lies the moral ground of doing what is right. Today’s consumers are harsh in their judgment and quick to share their opinions when they per- ceive a company as unfair to some or all customers. Also challenging for decision-makers regarding pricing are potential conflicts of interest with distribution channel partners, and the difficulties of selling in the B2B model. Taken together, these constraints increase the operational complexities of managing pricing strategies. A closer look at each follows.

Ethics and Legality Is it fair for different people to pay different prices for the same thing? Should a student and a millionaire pay the same for a gallon of milk? Should a person in the United States and in a poorer country in Africa pay different prices for a cancer-treating drug? These questions are not easily answered. Discounted prices for those on fixed incomes, such as students or senior citizens, have been a visible part of retail pricing structures for decades. But less transparent use of segmented pricing can backfire, as examples mentioned earlier have shown. In a Marketing 3.0 world, consumers increasingly bring an expectation that they will be able to customize offerings to their own tastes, that such customization will

In conclusion, it’s important for marketers to recognize how changing prices changes everything else in the marketing mix. Giving up profits is something no company would do without a defensible reason. Price changes can address internal objectives, such as a need to liquidate excess inventory, a desire to increase sales volume, or a way to facilitate campaign measurement. A price change can address external factors, such as signaling a shift in positioning to the target market. Any of these reasons offers sufficient benefit to warrant including sales promotions as part of a company’s overall pricing strategy. It’s important that the discount be used strategically—that is, to address one of three objectives:

1. Encourage first-time trial, 2. Increase engagement between seller and buyer, or 3. Reward loyalty.

Questions to Consider

Many people consider shopping for bargains to be part of their everyday “financial fitness routine.” Some take it to such lengths they identify as “extreme couponers.” Do you look for sales promotions and price discounts when you shop? Does the type of item you are shopping for affect your interest in discounts and sales promotions? Would you pass up buying your favorite brands to save money? What could marketers learn by observing your behavior with regards to strategic use of sale pricing?

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CHAPTER 5Section 5.5 Challenges to Effective Pricing Strategies

not be reflected in high prices, and that in many cases they will be able to collaborate on what the price will be (Name Your Own Price) as well as what features are included in that price. These trends make more opaque just what each customer pays and what each customer gets, mitigating somewhat the potential of segmented pricing to be perceived as unfair. How marketers frame their prices as part of their positioning strategy has much to do with perceptions of the ethics of their pricing practices.

Marketers not only risk consumer dissatisfaction but also legal sanctions if their pricing strategies are unethical or illegal. Since 1890, the federal government has acted to maintain fair price competition through antitrust law. The United States maintains stringent laws; the rest of the world is following suit, although traditionally European and Asian coun- tries impose fewer constraints through law (Perner, 2008). Failure to comply can bring risk of substantial fines and even prison sentences. Practices such as requiring a customer to buy a less-desired product in order to buy a more desired one, collusion among busi- nesses to fix prices, price discrimination (selling identical products to different buyers at different prices), or predatory pricing (temporarily selling below a sustainable price to undermine competition) are illegal. A deeper study of pricing law falls outside the intent of this introductory book but is essential for any marketer responsible for organizational pricing strategy decisions.

Channel Conflicts Members of a distribution chan- nel may find they have conflict- ing interests. Any partner in the channel may seek to increase profits or sales volume at the expense of other channel part- ners. For example, retailers seek- ing to maximize category profits may offer promotional pricing on one brand and thus hurt a competing brand’s sales, since consumers can easily switch if one brand goes on sale. Retail- ers may advertise a few highly discounted items to generate store traffic; the manufacturers of those items may resent the positioning effect of the deep discount, which can send a mes- sage that the item is low-quality or being discontinued. As dis- cussed in Chapter 4, channel partner relationships are difficult to change, so channel con- flicts arising from pricing decisions can cause significant disruption that is hard to repair.

Selling to Organizations Selling goods and services to organizations can be substantially more complex than sell- ing to consumers. In a business, the single consumer is replaced by an organizational

Channel partners can have conflicts of interest arising from pricing decisions, as when a retailer advertises a sale price on one brand and thus hurts competing brands’ sales.

Associated Press

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CHAPTER 5Section 5.5 Challenges to Effective Pricing Strategies

The concerns discussed above make any organization’s pricing decisions complex. Ethical and legal matters, channel partners’ perspectives, and the functional and psychological factors affecting the buying center in a business-to-business purchase exchange are all

function, termed the buying center, in which several people participate in the buying decision. Initiators, users, buyers, gatekeepers, and deciders may all be involved in the buying center (Nagle & Holden, 1995). Initiators generate purchase requests, users help identify specifications for the purchase, and buyers have the formal responsibility to authorize the purchase. Large organizations will have dedicated purchasing agents while smaller organizations may be less structured, making it difficult for a seller to identify who holds buying responsibility or authority. Also influencing the buying process in an organization are gatekeepers who control the flow of information and contact with the buying center, and deciders (who may be the buyer or may serve in a less visible role) who have the final authority to select a vendor. Businesses selling to other businesses need a sales staff knowledgeable in the subtle dynamics of the buying center. Too frequently salespeople underestimate the impact or fail to understand the perspectives of the differ- ent individuals in the buying center.

Managing Complexity “More and more, today’s pricing environment increasingly demands better, faster, and more frequent pricing decisions than ever before. It is also forcing companies to take a whole new look at pricing and its role in an increasingly complex marketing environ- ment” (Gould, 1979). That statement was originally published in Business Week in April 1974, but it is just as relevant today. The humanity-centric consumers of the Marketing 3.0 era, who demand responsibility to a triple bottom line of economic value, environmen- tal health, and social progress in the companies they do business with, are not likely to buy from sellers who fail to offer full transparency about pricing or to involve customers as collaborative partners in creation of value. Pricing strategies must reflect authenticity, including authentic differences in value for each market niche under a segmented pricing strategy. Positioning strategies must reflect clear competitive differentiation, to move the conversation away from price toward economic value.

The key to managing these complexities lies in tracking the effectiveness of the strategy in use. Information on how current strategic decisions perform is the best tool for deciding whether to change or maintain the current strategy, and if a change is warranted, what strategic direction it should take.

Field Trip 5.5: Finding the Best Value in Film Transfer Services

In the previous chapter you learned about film transfer services’ use of distribution strategies as a competitive differentiator. Now, return to the world of film digitization for a lesson in the complexities of pricing strategies.

Visit three film transfer services’ websites (search on “film transfer” to select your consideration set) and examine their posted prices. Assume you have three 5-in. reels of Super 8 mm film you would like transferred. Can you compare prices? What factors, such as quality of transfer and turnaround time, affect the price? Can you ascertain which vendor offers the best economic value for you?

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CHAPTER 5Case Study: Price War in Mariachi Plaza

challenges to any organization’s pricing decisions. Pricing decisions directly affect sales volume and profitability, and indirectly affect the other aspects of the marketing mix: what is designed into the offering to give it economic value (Product), its effect on intermediar- ies in the distribution channel (Place), and the objectives and effectiveness of advertising (Promotion). In the end, it is the customers in the targeted market segment who make the decision about which offering presents the best value and who have the most input on a company’s pricing strategy.

Questions to Consider

Apply what you have learned about today’s consumer from this and previous chapters. Do you see challenges to effective pricing strategies arising from expectations of consumers in the Marketing 3.0 era? How is pricing strategy affected when consumers reach for fulfillment of their higher needs through their buying decisions?

Case Study: Price War in Mariachi Plaza

In a corner of the Boyle Heights neighborhood just east of downtown Los Angeles you’ll find Mariachi Plaza—a long-established hiring center for musical ensembles that play the traditional music of western Mexico. Mariachi musicians play party music for christenings, quinceañeras, weddings, and other celebrations in Los Angeles’s Latino community, wearing the silver-studded costumes and wide-brimmed sombreros characteristic of the Jalisco region. Mariachi Plaza, an established marketplace for the bands since the 1940s, has become an attraction in its own right, with huge murals and a bandstand. The musicians for hire there are professional entertainers who are well-paid for their performances.

Or were. A dispute over what they should charge heated up in the summer of 2011, reported in the New York Times (Medina, 2011). Since about 2000 the established musicians of Maria- chi Plaza—and their custom- ers—knew how much a maria- chi should charge. The going rate had been about $50 per hour for each musician in the ensemble. By a decade later, two factors were challenging the sta- tus quo—a 50 percent drop in demand for bookings and a rise in competition from newcom- ers, some willing to lower their rate to $30 per hour. Some also began charging only for time

Many musicians in Mariachi Plaza have had to drop their rates to book an event as the demand has dropped and more competitors fill the marketplace.

Associated Press

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CHAPTER 5Case Study: Price War in Mariachi Plaza

played, not including charges for travel and setup, which further undercut the common pricing practices of Mariachi Plaza. The old-timers shared an opinion that the newer musi- cians brought a lower artistic quality, lacked knowledge of the traditional song repertoire, and even fell short in their costuming (Hoag, 2011). Shouting matches and even fistfights erupted over who would get gigs, the Times reported.

In 2011, roughly 150 of the 400 musicians formed a group to set a minimum price expec- tation (Hoag, 2011). Those who joined the United Mariachi Organization of Los Angeles agreed to pay $10 a month and to hold the line at $50 an hour, in return for a photo iden- tification card marking them as authentic practitioners with high professional standards. The organization helps its members deal with booking contracts; complaints of bounced checks and reneged-on prices have been numerous.

Consider the situation from the point of view of the (fictional) recently arrived musician Jose Aguinaga, whose talented ensemble Grupo Danzón was well-respected in Jalisco before arriving in the United States. Should he and his musicians cast their lot with the professionals who join the United Mariachi Organization or side with the newcomers who, due to their lower rates, are more likely to find work? Pricing strategy is crucial to Jose’s success in the music business.

How is psychology affecting potential buyers’ decisions about entertainers in Mariachi Square? If they’ve booked bands there in the past, they may be familiar with the reference price point of $50 per hour per musician established a decade ago. More recent customers may be unaware of the downward trend and fix on $30 as “fair.” Customers’ perception sets the “ceiling” price Jose can charge. Jose will need a pricing strategy that recognizes his potential customers’ price sensitivity.

He sets the “floor” with a breakeven analysis that factors in his fixed and variable costs, including instruments, costumes, and the pay he and his band members need to support their families. Complicating this calculation is Jose’s need to charge enough to cover the periods when the band is not working—unpredictable at best. Inputs to Jose’s strategic pricing plan, in addition to costs, include the characteristics of the target market (with its reference pricing), environment (competitive), and his choice of differentiation strategy.

Is segmented pricing an option for Grupo Danzón? Several of the segmentation tactics listed in this chapter could be effective: The band could vary prices by form (offering dif- ferent musical sets designed to appeal to different market niches), by geography (charging for travel), by purchase quantity (offering discounts for multiple bookings), or by product bundling (adding party planning to the band’s service offering), for example.

Jose knows he must find a competitive differentiation strategy that will allow him to become profitable by charging higher prices. Jose’s pricing strategy will have to be neu- tral, as opposed to a skim or penetration approach, because Los Angeles’s mariachi bands have been experiencing a declining stage in the Product Life Cycle relative to their popu- larity in the 1950s and 1960s, but mitigated by the steady growth of the area’s Hispanic population.

He must find a way to stand out for something other than price. As a newcomer he needs to encourage trial by new customers who, if satisfied, will reward him with referrals and

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CHAPTER 5Case Study: Price War in Mariachi Plaza

future bookings. Joining the United Mariachi Organization will position him as part of a proud heritage, “the real deal” among imitators.

Sales promotions have proven effective to encourage trial. In sales promotions Jose has found his differentiating factor; few other mariachi bands have adopted this technique. To stand out among the Union members, Jose Aguinaga and his Grupo Danzón begin offer- ing free samples in the form of music videos on DVDs, accompanied by coupons promis- ing a 20 percent discount from his posted rate of $50 per hour per musician. On the disc, in addition to his band’s traditional Jalisco musical stylings, he includes videos showcasing several updated genres Grupo Danzón has mastered—including tunes by Pink Floyd and Michael Jackson. There’s no group in Mariachi Plaza quite like them. Tracking redemption of the coupons will let Jose know if his strategy is effective—as will the buzz his unusual take on Mariachi music creates. (Will the videos go viral on YouTube?)

Fundamentally, pricing for mariachi bands is a function of supply and demand. With demand falling relative to supply, the musicians are experiencing increasing elasticity of demand. Those who want to work must develop strategic responses, including finding new ways to promote themselves beyond the boundaries of Mariachi Plaza. Those who wish to use Mariachi Plaza as a marketing venue should respect its traditions—including pricing structure.

Challenge Question

When customers grow accustomed to negotiating prices, whether through haggling, customizing, or Name-Your-Own-Price exchanges, a company loses some degree of control over the profitability of each sale. Therein lies the appeal of a return to a fixed-price strategy. But this chapter has argued that a segmented price strategy, in which a company charges different prices to different customer seg‑ ments, yields more revenue. Is there a difference between a fixed-price policy and a one-price policy? Does a segmented pricing policy undermine the relationship between price and value?

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CHAPTER 5Post-Assessment

Post-Assessment

1. Law firms were among the last user groups to give up the computer program WordPerfect for document processing because of the cost of converting large libraries of document templates to new software. Which term BEST applies to this example?

a. Reference pricing b. Signposts c. Switching costs d. Price sensitivity

2. Which of the following BEST describes the nature of a demand curve in terms of the relationship of supply to demand?

a. A slope downward as price decreases and quantity increases b. A slope upward as price decreases and quantity increases c. A slope downward as quantity decreases and price increases d. A slope downward as quantity and price decrease

3. Which pricing strategy is associated with reducing strain on infrastructure with a fixed capacity?

a. Peak load b. Dynamic pricing c. Yield management d. Opaque exchange

4. Which of the following is NOT a component of the environment factor that affects pricing decisions?

a. Competitors b. Social concerns c. Target profit d. Economic conditions

5. When a clothing retailer temporarily adjusts prices downward to get rid of last season’s fashions, that is an example of a:

a. Pull tactic b. Sales promotion c. Trade allowance d. Premium

Answers 1. c. Switching costs. The answer can be found in Section 5.1.

2. a. Slope downward as price decreases and quantity increases. The answer can be found in Section 5.1.

3. c. Yield management. The answer can be found in Section 5.2.

4. c. Target profit. The answer can be found in Section 5.3.

5. b. Sales promotion. The answer can be found in Section 5.4.

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CHAPTER 5Critical Thinking Questions

Key Ideas to Remember

• The price established for a product or service is critical because the price affects the Customer Value Equation. Psychological factors and economic principles affect buyers’ purchase behavior, which influences sellers’ pricing decisions.

• Economic concepts that affect pricing strategy include supply and demand, elasticity of demand, price sensitivity, and the breakeven point. In light of these effects, marketers should consider a segmented pricing strategy that identifies specific markets and matches differentiated offerings to them, because of the strategy’s potential to maximize revenue, even though a segmented strategy is difficult to implement.

• Inputs to the pricing decision include costs, target market, environment, and dif- ferentiation strategy. Cost takes into account the breakeven analysis, which sets the “floor” below which prices cannot yield profit and the “ceiling” above which customer demand falls off. Target market involves customers’ perception of value, the elasticity of their demand, and their price sensitivity. Environment includes external factors such as economic conditions, intermediaries, competitors, and social concerns. Differentiation strategy recognizes the interactivity of product strategy and price in creating a product’s positioning.

• Adjusting prices via short-term sales promotions can achieve strategic objectives, including encouraging first-time trial, increasing engagement between seller and buyer, and rewarding loyalty. Sales promotions must be measured to track their incremental contribution to sales.

• Pricing decisions are made more complex by challenges that include ethical and legal matters, channel partners’ perspectives, and the certain complications unique to business-to-business purchase exchanges. Pricing decisions interact with the other four P’s of the marketing mix, directly affecting sales volume and profitability.

Critical Thinking Questions

1. If you were starting a coffee shop across the street from a Starbucks, how might you use buyer psychology concepts discussed in this chapter (reference pricing, signposts, sale signs, and prices ending in 9) to set your pricing strategy?

2. What differentiates a sales promotion from other price adjustments? 3. Identify factors influencing elasticity of demand. 4. Explain how calculating the breakeven point and estimating consumers’ price

sensitivity assist in price determination. 5. Give examples that demonstrate how the economic concepts of supply and

demand, elasticity of demand, price sensitivity, and breakeven point affect pric- ing strategy.

6. Consider a locally owned hardware store that competes with several national- brand “big-box” stores in its trade area. Justify which is better for the hardware store: a pricing strategy that features a sale once a month, or everyday low pric- ing. Explain your thinking.

7. Project a future in which the business model for flash sale websites focuses on spotlighting brands and using data gathered by tracking individual consumer behavior on the site. Could a segmented pricing strategy work for these “second- generation” flash sale sites? Could a “Name Your Own Price” strategy work? Explain your thinking.

8. How does the concept of value-based pricing lead to a variable pricing strategy?

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CHAPTER 5

bonuses A consumer-oriented promo- tional strategy involving payment or gift added to what is expected.

breakeven analysis The point where total revenue received equals the total of fixed and variable costs associated with the sale of the product.

buying center Within a business, a func- tional unit charged with evaluating and purchasing goods and services. Initiators, users, buyers, gatekeepers, and deciders may all be involved in the buying center.

cash rebates A consumer-oriented promo- tional strategy involving money returned on what has already been paid for an offering.

co-creation model Buyers may bundle options to design products that suit their individual ideas of value.

competition-based A pricing approach focused on setting prices based on com- petitors’ prices for similar offerings.

contests A consumer-oriented promo- tional strategy involving prizes given to winners who are drawn from a pool of entrants who have completed a required task.

cost-plus A pricing approach focused on adding a standard markup to the cost of the product that accommodates fixed and variable costs of production.

coupons A consumer-oriented promo- tional strategy involving documents that can be exchanged for a financial discount.

dynamic pricing model Buyers and sell- ers collaborate to establish a price, accept- ing trade-offs in deliverables for favorable pricing.

economic value The reference price that a buyer assigns to the features that dif- ferentiate an offering from the alternatives available at the reference price.

elasticity of demand The degree to which demand for an offering varies with its price. Demand is highly elastic when a small change in price brings about a large change in sales, highly inelastic if a large price change has little effect on sales (demand).

equilibrium point The position of a mar- ket price that generates an equal amount of demand and supply for a product or service.

fixed costs Costs associated with normal operations of the business, such as rent or insurance, that do not change with changes in production volume.

fixed pricing strategy A strategy in which the same price is charged to all customers, as opposed to a variable pricing strategy.

flash sales A trend beginning in 2007 of members-only websites selling designer brands at bargain prices for very limited time periods while collecting consumer data by tracking online behavior.

high-low pricing A strategy in which a company intentionally sets its regu- lar prices higher and then reduces the price structure during frequent sales promotions.

list price A manufacturer’s, distribu- tor’s, or retailer’s quoted, published, or displayed price on which discounts are computed. Also called manufacturer’s sug- gested retail price (MSRP).

markup Adding a constant percentage to the cost paid for an item to arrive at its selling price.

Key Terms to Remember

Key Terms to Remember

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CHAPTER 5Key Terms to Remember

manufacturer’s suggested retail price (MSRP) See list price.

neutral pricing A strategy calling for matching prices of the general market.

opaque exchanges Buying exchanges in which sellers strategically withhold information from customers who may not know the exact features of their purchase at the point of payment, a feature of the Name Your Own Price approach.

peak-load pricing Charging higher prices during periods of rising demand (viable only when few competitors exist).

penetration pricing A strategy calling for keeping prices low in comparison to competitors’ and widely promoting an offering, to quickly achieve the most sales to the most buyers possible.

pocket price The price collected by a seller in a particular transaction after accounting for all relevant discounts given to channel partners or the end consumer.

premiums A consumer-oriented promo- tional strategy involving items given free or at reduced cost with purchases of other items.

price The money or other consideration exchanged for the ownership or use of a good or service, representing a quantifi- able way to measure the value customers place on that offering.

price discrimination The practice of charging different prices to different buy- ers for goods of like grade or quality, pro- hibited under the Clayton Act as amended by the Robinson-Patman Act.

price sensitivity The amount by which changes in a product’s cost tend to affect consumer demand for that product.

price waterfall analysis A tool used to cal- culate how much revenue companies keep from each sale after transactional costs have been subtracted.

profit maximization A strategic approach with the objective of generating the highest possible net income over time.

reference pricing In buyer psychology, an amount representing a fair price in the consumer’s mind that is remembered, researched, or inferred from the buying situation.

refunds A consumer-oriented promo- tional strategy involving money returned on presentation of proof of purchase of an offering.

sales incentives A promotional strategy involving programs that reward interme- diaries for superior performance.

sales promotions A short-term marketing strategy intended to stimulate purchases over a specific time period, by offering a reason to buy in addition to the service rendered by the offering regardless of price.

samples A consumer-oriented promo- tional strategy involving free products dis- tributed in hopes of obtaining future sales.

segmented pricing Selling a product or service at more than one price, where the difference in prices is based on differences other than costs of production.

signposts In buyer psychology, the ten- dency of reference prices on certain items to signal a store’s pricing in general.

skim pricing A strategy calling for setting prices high to attract higher income groups for luxury or status goods, or to extract maximum returns from a market before competitors emerge.

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CHAPTER 5Key Terms to Remember

supply and demand The amount of a product sellers make available (supply) and the amount buyers want to purchase (demand).

sweepstakes A consumer-oriented pro- motional strategy involving prizes given to winners selected by chance from a pool of entrants.

switching costs The costs associated with switching suppliers when the purchase will require buyers to spend on additional goods or services to gain its full value.

target profit A pricing approach focused on calculating breakeven costs of making and marketing a product, and selecting a price to make a target profit above that cost.

trade allowances A promotional strategy involving financial incentives to channel partners to purchase or promote specific offerings.

value-based A pricing approach focused on using buyers’ perception of value to design an offering that can be sold profitably.

variable cost A cost that fluctuates with production volume; for example, process materials or sales commissions.

variable pricing strategy A strategy in which different prices are charged to dif- ferent customers or at different times.

volume maximization A strategic approach in which a company’s primary objective is to generate as much sales vol- ume (and revenue) as possible over a short time frame.

yield management Strategic control of inventory to maximize yield or profits from a fixed, perishable resource.

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