1

MKT 322
Ch 7: PRICING STRATEGY
1. OBJECTIVES
To understand the internal and external factors affecting a firms pricing
decisions.
To understand the three approaches in setting prices.
To understand the different types of pricing strategies.
2. DEFINITION
Price is the amount of money charge for a product or service of the sum of the
values that consumers exchange for the benefits of having or using the product or
service.
Price goes by many names such as rent, tuition fees, fare, rate, interest, toll,
premium, etc.
Price is the only element in the marketing mix that produces revenue, all other
elements represent costs. Price is also one of the most flexible elements in
marketing mix.
3. FACTORS TO CONSIDER WHEN SETTING PRICES
Pricing decisions of a company are affected by internal and external
environmental factors as shown in figure 1
Figure 1 Factors affecting price decisions
Internal factors
Marketing
objectives
Marketing mix
Cost
Organizational
consideration

External factors
Pricing
decisions

PDF created with pdfFactory Pro trial version www.pdffactory.com

Nature or
market &
demand
Competition
Other
environmental
factors

2
3.1

Internal factors
(a) Marketing objectives
Survival
Current profit maximization
Market share leadership
Product quality leadership

(b) Marketing mix strategy

Price is the only one of the marketing mixes tools that a company uses to
achieve its marketing objectives.
Price decisions must be coordinated with product design, distribution, and
promotion decisions to form a consistent and effective marketing
programme.
(c) Cost
Costs are another internal factor that set the floor for the price that the
company can charge.
Companies want to charge a price that covers all its costs for producing,
distributing, and selling the product, and provides a fair rate return for its
effort and risk.
(d) Organizational considerations
Management must decide within the organization who should set the
prices.
In small companies, top management usually makes all the pricing
decisions.
In industrial markets, sales person often enter into the process by
negotiating certain aspects of the contract and therefore price.

3.2

External factors
(a) Market and demand
Whereas costs set the lower limit of prices, the market and demand set the
upper limit. Pricing freedom varies with different types of markets:

Pure competition is a market in which many buyers and sellers trade

in a uniform commodity. No single buyer or seller has much effect on
the going market price.

Monopolistic competition is a market in which many buyers and

sellers trade over a range of prices rather than a single market price.
Sellers try to develop differentiated offers.

PDF created with pdfFactory Pro trial version www.pdffactory.com

Oligopolistic competition is a market consisting of few sellers only

and they are highly sensitive to each others pricing and marketing
strategies.
v

Pure Monopoly is a market in which there is a single seller, it

may be a government monopoly, a private regulated monopoly,
or a private non regulated monopoly.

Level of demand also affect the pricing decisions of product:

Demand curve shows the number of units the market will buy in a
given time period at different prices.
v Price elasticity - is a measure of the sensitivity of demand to
changes in price. It is a price - demand relationship.
Demand is inelastic if it hardly changes with a small change in
price. Examples:
Buyers are less price-sensitive when the product they are
buying is unique or high quality, prestige, or exclusiveness.
Buyers are less price-sensitive when substitute products are
hard to find or cannot easily be compared.
Buyers are less price sensitive when the total expenditure
for a product is low relative to their income or the cost is
shared by another party.

Demand is elastic if it changes greatly with a small change in

price.

(b) Competitors costs, prices and offer

Company needs to benchmark its costs, prices, and offers against its
competitors, so that it can use them as a starting point for its own pricing.
Company also needs to learn its competitors reaction to the firms pricing
moves.
Example, if you are considering to buy a Canon camera, you may evaluate
the price of comparable products such as Nikon, Panasonic, Pentax, ect.
(c) Other external factors
Economic conditions such as boom or recession, inflation, or interest
rates.
Resellers policies must be considered especially if they do not match
the suppliers. Will the set prices give resellers a fair profit and encourage
their support?
Government it has regulatory power to impose law that will influence
on pricing decision.

PDF created with pdfFactory Pro trial version www.pdffactory.com

4
4. GENERAL PRICING APPROACHES
4.1 Cost based pricing
a) Cost-plus pricing
an approach that adds a standard markup to the cost of the product.
Formulas used are:
Unit cost = variable cost + fixed costs/unit sales
Markup price = unit cost/(1-desired return on sales)
The standard markup approach may not make much sense because it ignores
current demand and competition.
It remains popular because:
v Sellers are more certain about costs than about demand
v Pricing is simplified since it is tied to cost
v Prices tend to be similar when all firms in an industry use this
approach and thus price competition is minimized.
b) Break-even pricing/target profit pricing
Setting price to break even on the costs of making and marketing a product ,
or setting price to make a target profit.
It uses a break-even chart that shows the total cost and total revenue at
different levels of sales.
Formula:
Target return price = unit cost+(desired return x invested capital)/unit
sales
Break even volume = fixed cost/(price-variable cost)
Although break-even analysis and target profit pricing can help the company
to determine minimum prices needed to cover expected costs and profits
they do not take the price-demand relationship into account.
When using this method, the company must also consider the impact of
price on the sales volume needed to realize target profits and the likelihood
that the needed volume will be achieved at each possible price.

4.2 Perceived value pricing (value based pricing)

Value based pricing is setting priced based on buyers perceptions of value rather
than on the sellers cost.
The company sets its target price based on customer perceptions of the product
value. The targeted value and price then drive decisions about product design
and what costs can be incurred.
It is a reversed process compared to cost based pricing. Refer to figure 2.

PDF created with pdfFactory Pro trial version www.pdffactory.com

5
Figure 2 Cost based vs value based
Cost based pricing
Product

Cost

Price

Value

Customers

Cost

Product

Value based pricing

Customers

Value

Price

Company using this approach must find out what value the buyer assigns to
different competitive offers.
Value pricing strategies mean offering just the right combination of quality and
good service at a fair price. In many instances this has resulted in the company
either overcharge or undercharge the product.
4.3 Competition based pricing
Going rate pricing price setting are based largely on following competitors
prices. This approach is popular, firms feel that the going rate represents the
collective wisdom of the industry concerning the price that yields a fair return.
They also feel that holding to the going rate price will prevent harmful price
wars.
Sealed bid pricing the firm sets prices based on how the firm thinks competitors
will price rather than on its own costs or demand estimates. Here, the firm wants
to win a contract through tender, and wining the contract required pricing lower
than other competitors. Yet the firm cannot set its price below a certain level to
harm its position.
5. PRICING STRATEGIES
5.1 New product pricing strategies
Price skimming involves setting a high price for a new product to skim
maximum revenue from the segments willing to pay the high price.
v Products quality and image must support its higher price and enough
buyers must want the product at that price.
v Cost of producing a small volume cannot be too high that they cancel
advantage of charging more.
v Competitors should not be able to enter the market easily and undercut the
high price.

PDF created with pdfFactory Pro trial version www.pdffactory.com

6
Penetration pricing is setting a low price for a new product in order to attract a
large number of buyers and to gain large market share under the conditions that:
v Market is highly price-sensitive.
v Low rice must help keep out competition
v Production and distribution costs must fall as sales volume increases.
5.2 Product mix pricing strategies
Product line pricing it involves setting the price steps between various
products in a product line based on cost differences between the products,
customer evaluations of different features, and competitors prices.
v Example: A mans clothing store might carry mens suits at three price
levels - $150, $250, and $350. The sellers task is to establish perceived
quality differences (low, average, high quality) that support the price
differences.
Optional product pricing it involves the pricing of optional or accessory
products along with a main product.
v Example: automatic window control, power steering, and CD player of
automobile.
v GMs pricing strategy is to advertise the stripped down model at a base
price to pull people into showrooms and then to devote most of the
showroom space to showing option-loaded cars at higher prices.
Captive product pricing is setting a price for products that must be used along
with a main product, such as blades for a razor and film for a camera.
v Producers of the main product offer them at low prices and set high
markup on the supplies
v Examples; HP makes very low profit on its printers but very high margins
on printer cartridges and other supplies.
v In service, it is called two part pricing where the price of the service is
broken into a fixed fee and a variable usage rate. Example; telephone
service.
By product pricing this involves setting a price for by-product in order to make
the main products price more competitive.
v Examples; a lumber mill selling wood chips, palm oil milling selling palm
kernel residues; zoos and their waste product.
v Manufacturer will seek a market for these by product and should accept
any price that covers more than the cost of storing and delivering them.
v This practice allows the seller to reduce the main products price to make
it more competitive.
Product bundling pricing it involves combining several products and offering
the bundle at a reduced price.

PDF created with pdfFactory Pro trial version www.pdffactory.com

7
v Example; toothpaste bundle with toothbrush in order to promote the sales
of toothbrush that consumers might not otherwise buy due to its poor
design or quality.
5.3 Price adjustment strategies
Companies usually adjust their basic prices to account for various customer
differences and changing situations.
a) Discount and allowance pricing
Cash discount is a price reduction to buyers who pay their bills
Quantity discount price reduction to buyers who buy large volumes
Functional or trade discount price reduction offered by the seller to trade
channel members who perform certain functions such as selling, storing, and
record keeping
Seasonal discount is a price reduction to buyers who buy merchandise or
services out of season. Seasonal discounts allow the seller to keep production
steady during an entire year.
Allowance is a price reduction given for turning in an old item when buying
a new one (example, automobile trade in). Promotional allowances are
payments or price reductions to reward dealers for participating in ad and
sales support programmes.
b) Segmented pricing
Selling a product or service at two or more prices, where the difference in
prices is not based on differences in costs. Possible forms include;
v Customer segment pricing - different customer pay different prices for
the same product or service.
v Product form pricing different versions of the product are priced
differently but not according to differences in their costs
v Location pricing company charges different prices for different
locations, even though the cost of offering each location is the same.
v Time pricing prices vary by season, the month, the day, or even the
hour.
c) Psychological pricing
Psychological pricing encourages purchases based on emotional rather than
rational responses. It is used most often at the retail level but of limited use
for industrial product.
Odd-Even pricing is a practice by ending the price with certain numbers in
order to influence buyers perceptions of the price or the product.
A product priced at odd ending (e.g.$99.99) will foster certain psychological
perception that the product is less than $100 and is a bargain.
A product price with even ending (e.g. $200.00) will influence a customer to
view the product as being a high quality, premium brand.

PDF created with pdfFactory Pro trial version www.pdffactory.com

8
Prestige pricing is to set the price at an artificially high level to provide
prestige or a quality image. Example, perfume, jewelry, liquor, etc
Reference pricing prices that buyers carry in their mind and refer to when
they look at a given product. Sellers can influence or use these consumers
reference prices when setting prices.
d) Promotional pricing
This is temporarily pricing products below the list price, and sometimes even
below cost, to increase short term sales.
Loss leader pricing is to set price below the usual markup, near cost or
below cost. It is used by supermarket or departmental stores to attract
customer to the store in the hope that they will buy other items.
Special event pricing involves advertise sales or price cutting linked to a
holiday, season, or event.
Cash rebates seller offer cash rebate to consumers who buy the product
from them within a specific time period.
Low interest financing/longer warranties/free maintenance this is
offered by manufacturers to reduce the customers price
Discount seller may simply offer discounts from normal prices to increase
sales and reduce inventories.
e) Geographical pricing
Price adapted to different part of the country, such as;
FOB origin pricing is a geographical pricing strategy in which goods are
placed free on board a carrier and the customer pays the freight from the
factory to the destination.
Uniform delivery pricing company charges the same price plus freight to
all customers regardless of their location.
Zone pricing the company set up two or more zones, all customers within a
zone pay the same total price, and this is higher in the more distant zones.
Freight absorption pricing company absorbs all or part of the actual
freight charges in order to get the business.
FOB destination a price indicating that the producer is absorbing shipping
costs. It is used to attract distance customers.
6. INTIATING PRICE CHANGES
After developing their pricing structures and strategies, companies often face
situation in which they must initiate price changes or respond to price changes by
competition.
Initiate price cut
v Excess plant capacity
v Decline market share
v Intend to dominate market through lower costs

PDF created with pdfFactory Pro trial version www.pdffactory.com

9
Initiate price increase
v Cost inflation
v Over demand
Customers reaction to price changes
v Price cut.
Current models are being replaced by newer models
Faulty product
The firm is in financial trouble
Price will come down even further
Quality has been reduced
v Price increase.
Strong demand
Product quality is exceptionally good
Suppliers are profiteering
Competitors reaction to price changes
v The company is trying to steal market share
v The company is doing poorly and trying to boost its sales
v Want the whole industry to cut prices to increase total demand
Responding to competitors price changes
v Maintain price believing that it would lose too much profit if price
reduced, it would not lose much market share, and it could regain market
share when necessary
v Maintain price and add value the leader could improve its product,
services, and communications. Firm may find it more profitable to
improve quality than to cut price and operate at a lower margin.
v Reduced price drop its price to match competition. It might do so if (1)
its cost fall with volume (2) it would lose market share because the market
is price sensitive (3) it would be hard to rebuild market share once it is
lost.
v Increase price and improve quality raise price to cover rising costs,
while improving quality to justify higher prices.
v Launch a low price fighter line add lower price items to the line or
create a separate lower price brand.

PDF created with pdfFactory Pro trial version www.pdffactory.com