Designing Pricing Strategies and Programs

SETTING THE PRICE – Marketers follow a six-step procedure in setting a product’s price.

STEP 1: SELECTING THE PRICING OBJECT – The five major objectives pursued through pricing:
1. Survival – short-term objective, overcapacity, intense competition
2. Maximum current profit – maximum profit, cash flow, ROI
3. Maximum market share – market-penetration pricing, price sensitive market
4. Maximum market skimming – high demand, few competitors, superior product image
5. Product-quality leadership – premium products at premium prices

STEP 2: DETERMINING DEMAND – Price affects demand. The relationship between alternative pricing
and the resulting current demand is reflected by the DEMAND CURVE.

PRICE SENSITIVITY – Consumers are less sensitive to price when:

*The product is more distinctive *Part of the cost is borne by another party
*Buyers are less aware of substitutes *The product is used with items bought
previously
*Buyers cannot easily compare the quality of substitutes *The product is seems to have more
quality/prestige/exclusiveness
*The expenditure is a lower part of the buyer’s total income *Buyers cannot store the product
*The expenditure is a small part of the total cost of the end product

PRICE ELASTICITY OF DEMAND – If demand hardly changes with a small change in price, demand is
INELASTIC. If demand changes considerably, demand is ELASTIC. Demand is less likely to be elastic when
(1) there are few or no substitutes/competitors; (2) buyers do not readily notice the higher price; (3)
buyers are slow to change their buying habits and search for lower prices; (4) buyers think higher prices
are justified by quality differences, inflation, etc.

STEP 3: ESTIMATING COSTS – Demand sets the price ceiling, costs set the price floor.
Two Types of Costs – Fixed costs or overhead & Variable Costs which vary with production levels
Experience Curve/Learning Curve – Average cost per unit declines with accumulated production
experience
Activity-Based Cost Accounting – Identifies the real costs associated with serving different
customers
Target Costing – Price is set to achieve a desired profit margin

STEP 4: ALALYZING COMPETITORS’ COSTS, PRICES, OFFERS – The firm must take into account
competitors’ reactions to their offering. If the product/service is similar to the competition, they will not be
able to charge more than the competition. If the offering is superior to that of the competition, it can
charge more. The competition may respond with a price change at any time.

STEP 5: SELECTING A PRICING METHOD – The three C’s are major considerations in setting price.
Costs set the floor to the price, Competitors’ prices/substitutes’ prices provide a comparison,
Customers’ assessment of unique features set the ceiling to the price.

MARKUP PRICING – A standard markup is added to the cost. Most common in construction and service
industries. Works only if the marked-up price meets expected sales level.
TARGET-RETURN PRICING – Price is set to yield a targeted rate of return on investment. BREAK-EVEN
analysis determines the volume of units that must be sold in order to break even.
PERCIEVED-VALUE PRICING – The buyer’s perceptions of value are more important than cost.
VALUE PRICING – Company charges low price for high quality offering. Must become low-cost producer
without sacrificing quality.
GOING-RATE PRICING – Prices are largely based on competitors’ prices.
SEALED-BID PRICING – Prices are based on expectations of how competitors will price rather than in
relation to the firm’s costs.

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STEP 6: SELECTING THE FINAL PRICE

PSYCHOLOGICAL PRICING – Many consumers use price as an indicator of quality. Image pricing is
especially effective with ego-sensitive products such as perfumes, expensive cars, gifts.
OTHER MARKETING-MIX ELEMENTS – Consumers are apparently willing to pay more for known products
than unknown. The positive relationship between high prices and high advertising is strongest in the
later stages of the product life cycle for market leaders.
COMPANY PRICING POLICIES – Price must be consistent with company pricing policies.
IMPACT OF PRICE ON OTHER PARTIES – How will distributors, dealers, salespeople, competitors, suppliers,
government, etc. react to the price?

ADAPTING THE PRICE – Companies usually do not set a single price, but a price structure that reflects
several variables.

GEOGRAPHICAL PRICING – Company decides how to price its products to different customers in different
locations and countries. The company must also consider how they will get paid. Fifteen to twenty-five
percent of world trade is paid for in COUNTERTRADE, where buyers offer items other than cash as
payment. Some forms of countertrade are:
*Barter – direct exchange of goods or services with no money and no third party involved
*Compensation deal – seller is paid partly in cash and partly in products
*Buyback arrangement – seller sells plant, equipment, technology and accepts products made with the
equipment as partial payment
*Offset – seller received payment in cash but agrees to spend a substantial amount of it in that country
within a specified time period

PRICE DISCOUNTS AND ALLOWANCES – Companies will adjust prices in certain circumstances.
*Cash Discounts – price reduction for buyers who pay their bills promptly
*Quantity Discounts – price reduction for buyers who buy in large volumes
*Functional Discounts – offered to trade-channel members if the perform certain functions (selling,
storing, record keeping, etc.)
*Seasonal Discounts – price reduction for buyers who by merchandise or services out of season
*Allowances – extra payments designed to gain reseller participation in special programs (trade-in or
promotional allowances)

PROMOTIONAL PRICING – Seven pricing techniques designed to stimulate early purchase:

*Loss-leader pricing – stores drop prices on brand name items to increase traffic
*Special-event pricing – special prices in certain seasons to draw in customers
*Cash rebates – rebates offered to encourage purchases within a specified period (inventory clearance)
*Low-interest financing – just what it says
*Longer payment terms – stretching loans over longer periods to result in lower payments
*Warranties and service contracts – addition of free or low-cost warranties
*Psychological discounting – offering the item at substantial savings from the normal price

DISCRIMINATORY PRICING – Selling at two or more prices that do not reflect a proportional cost difference.
Price discrimination works when (1) the market has segments that show different intensities of demand;
(2) the lower-price segment cannot resell to the higher-price segment; (3) competitors cannot undersell
the firm in the higher-price segment; (4) the cost of segmenting and policing the market does not exceed
the extra revenue derived from price discrimination; (5) the practice does not breed customer resentment;
and(6) the price discrimination is not illegal (predatory pricing – selling below cost to destroy competition).
*Customer-segment pricing – certain customer groups pay different prices for same product/service
(senior citizen discounts)
*Product-form pricing – different versions of same product sell for different price without regard to
production cost
*Image pricing – same product sells for two different prices based on image differences
*Location pricing – same product is priced differently based on location (stadium seating)
*Time pricing – prices vary by season, day, or hour (cellular phones w/free weekends)

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PRODUCT-MIX PRICING – Price-setting logic must be modified when the product is part of a product mix.
*Product-line pricing – price points that distinguish products in a product line. Perceived quality
differences must justify price
*Optional-feature pricing – optional products, services, features offered along with the main product
*Captive-product pricing – some products require ancillary products (razors need blades) that allow
greater markup
*Two-part pricing – consists of a fixed fee plus a variable usage fee (telephone service)
*By-product pricing – sales of by-products which may allow the product to be sold at a lower price if
necessary
*Product-bundling pricing – selling a bundle of products for less than it would cost to buy the items
separately

INITIATING AND RESPONDING TO PRICE CHANGES – Firms may need to cut or raise prices in certain
situations.

INITIATING PRICE CUTS – Firms may cut prices due to excess plant capacity, declining market share, to
dominate the market through lower costs. Items to consider before initiating a price cut: could start a
price war, customers may assume lower price means lower quality, low price buys market share but not
loyalty, competitors may cut prices and have longer staying power

INITIATING PRICE INCREASES – Firms may increase prices to increase profit margin, to maintain profits in
the face of cost inflation, in anticipation of cost increases (anticipatory pricing), when the firm faces
overdemand and cannot supply all of its customers.

REACTIONS TO PRICE CHANGES – Reaction to price changes are most likely when there are few firms
offering the product, the product is homogeneous, and buyers are highly informed.

RESPONDING TO COMPETITORS PRICE CHANGES – The best response varies with the situation. Firms must
consider the product’s stage in the life cycle, its importance to the firm’s portfolio, the competitor’s
intentions and resources, the product’s price and quality sensitivity, the behavior of costs with volume,
and alternative opportunities.

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