Chapter 11 – Pricing Concepts and Strategies

In highly competitive markets, companies must be creative in finding ways to balance profits and
consumers.

The importance of pricing:

- A strategic opportunity to create value
- Not an afterthought to the rest of the MM
- Pricing signals quality or lack of quality

Price is usually ranked as one of the most important factors in purchase decisions – the only element in the
MM that generates revenue, and the easies tone to change.

The 5 C’s of Pricing

1. Company Objectives
- Profit orientation (maximize profits, target return pricing, target profit pricing)
- Sales orientation – increasing sales will help the firm more than will increasing profits
- Competitor orientation – firms should measure itself primarily against its competition. Competitive
Parity – a firm’s strategy of setting prices that are similar to those of major competitors.
- Customer orientation – sets prices to match consumer expectations.

2. Customers
- The most important C, all about understanding consumers reactions to different prices
- Customers want value and price is half of the value equation
- Prestige products – purchased for their status rather than functionality.
Price Elasticity of Demand: how do consumers respond to price
increases/decreases. = % change in quantity demanded / % change in price
Factors Influencing price elasticity of demand:
Income Effects:
- Generally, as people’s income increases, their spending behaviour changes
- Demand shifts form lower-priced products to higher-priced products
Substitution Effects:
- The greater the availability of substitute products, the higher the price elasticity of demand for any
given product
Price Elasticity
- Cross-Elasticity – the percentage change in demand for product A that occurs in response to a
percentage change in price of product B
- Complementary Products – products whose demand curves are positively related, such that they
rise or fall together; a percentage increase in demand for one result in a percentage increase in
demand for the other.
- Substitute Products – products for which changes in demand are negatively related – that is, the
percentage increase in the quantity demanded for Product A, results in a percentage decrease in the
quantity demanded for product B.

3. Cost
- Variable costs – moves in direct proportion to units produced
- Fixed costs – not affected by production volume
 - Total costs = VC + FC
- VC = VC per Unit X Quantity
- Total Revenue = Price X Quantity
- BE (units) = FC / CM per unit
BE Analysis limitations:
1. Average prices are more than likely used
2. Prices often get reduced as quantity increases because the
costs decrease, so firms must perform several break-even
analyses
3. A break-even analysis cannot indicate for sure how much
will sell.

4. Competition

- Look at text
- Price War – occurs when two or more firms compete primarily by lowering their prices

5. Channel Members
- Manufacturers, wholesalers, and retailers can have different perspectives on pricing strategies
- Manufacturers must protect against grey market transactions
- Grey Market – employs irregular but not necessarily illegal methods; generally, it legally circumvents
authorized channels of distribution to sell goods at prices lower than those intended by
manufacturer.

Pricing Strategies
1 – Cost-Based
- Start with cost, all costs are calculated on a per unit basis.
- Assumes costs don’t vary for different levels of production
- Requires all costs can be identified and calculated on a per-unit basis.
- Prices are usually set on the basis of estimates of average costs
- Same issues as profit issue orientation
2 – Competitor-Based
- Set prices to signal info of how product compares with competitors – whether its
lower/equal/higher
- Premium pricing
3 – Value-Based
- Setting prices that focus on the overall value of the product
- Consumer perceptions
How managers use value-based methods:
1. Improvement Value Model
- The manager must estimate the improvement value of a new product, the improvement value is an
estimate of how much more (or less) consumers are willing to pay for a product relative to other
comparable products.
2. Cost of Ownership Method
 - Determines the total cost of owning the product over its useful life
Pricing Strategies
1. Everyday low pricing (EDLP) – a strategy companies use to emphasize the continuity of their retail
prices at a level somewhere between the regular, non-sale price and the deep-discount sale prices
their competitors may offer.
- Value is created in different ways:
- Saves search costs of finding lowest overall prices
- High/low provides the thrill of the chase for the lowest price
2. High/Low Pricing
- Relies on the promotion of sales, during which prices are temporarily reduced to encourage
purchases
- More unreliable it would appear – but it actually creates a “thrill of the chase” deal hunters
3. New Product Pricing
- Price Skimming – selling a new product at a high price that innovators and early adopters are willing
to pay to obtain it; after the high-price market segment becomes saturated and sales begin to slow
down, the firm generally lowers the price to capture (or skin) the next most price-sensitive segment.
For this to work, the product has to be seen as breaking new ground in some way, offering
consumers new benefits currently unavailable in alternative products. Competitors cannot be able
to enter the market easy with a copy. Face high production costs as a drawback
- Market Penetration Pricing – setting the initial price low for the introduction of the new product
with the objective of building sales, market share, and profits quickly. Experience Curve Effect –
refers to the drop in unit cost as the accumulated volume sold increases, as sales continue to grow,
the costs continue to drop, allowing even further reductions in the price. Drawbacks: firm must have
capacity to satisfy demand, low price does not signal high quality, firms should avoid a penetration
strategy is some segments of the market are willing to pay more for the product

Consumers’ use of reference prices: the price against which buyers compare the actual selling price of the
product and that facilitates their evaluation process. Reference prices are typically from memory.

Pricing strategy is a long-term approach to setting prices broadly in an integrative effort based on the 5 C’s
Vs.
Pricing Tactics – short-term methods to focus on select components of the 5 C’s. A pricing tactic generally
represents either a short-term response to a competitive threat or a broadly accepted method of
calculating a final price for the customer that is short-term in nature.

Pricing Tactics – Consumers

Price Lining – establishing a price floor and ceiling for an entire line of similar products and then setting
price points in between to represent distinct differences in quality. Allows for easy comparison.
Price Bundling – pricing of more than one product for a single, lower price. Encourages: sales of slow-
moving items, stock up, trial of new brand, and incentive to purchase.
Leader Pricing – building store traffic by aggressively pricing and advertising a regularly purchased item,
often priced at or just above the store’s cost, in hopes they will pick up higher priced items as well.
Shoppers drugmart – good example.

Consumer Price Reductions

Markdowns – an integral component of high/low pricing strategy. Enables retailers to get rid of slow
moving or obsolete merchandise. Used to generate store traffic.
Coupon & Rebates – size discount, the more you buy the cheaper the unit cost. Goal of coupons: prompt
customers to try a product, reward loyal customers, or encourage repurchases. Hassle factor is higher for
rebates.
Quantity Discounts for Consumers – Coupons: retailer handles vs. Rebate: manufacturer issues

B2B Pricing Tactics and Discounts

Seasonal Discounts – an additional reduction offered as an incentive to retailers to order merchandise in
advance of the normal buying season. Designed to spur buyers into purchasing merchandise early.
Cash Discounts – ad additional reduction that reduces the invoice cost if the buyer pays the invoice prior to
the end of the discount period. Encourages buyers to pay before the discount period ends, seller benefits
either way.
Allowances – advertising or listing allowances (additional price reductions) offered in return for specific
behaviours. Advertising allowances are offered to retailers if they agree to feature the manufacturer’s
product in their advertising and promotional efforts. Listing allowances are offered to get new products into
stores and to gain more or better shelf price.
Quantity Discounts – providing a reduced price according to the amount purchased. Cumulative Quantity
Discount (offers a discount based on the amount purchased over a specified period and usually involves
several transactions) vs. Noncumulative Quantity Discount (offers a discount based on only the amount
purchased in a single order)
Uniform Delivered vs. Geographic Pricing – with Uniform Delivered pricing, the shipper charges one rate,
no matter where the buyer is located. With Geographic pricing, different prices are charged depending on
the geographical delivery area.

Legal & ethical Aspects of Pricing

1. Deceptive or illegal Price Advertising
- Deception Reference Prices – Volume Test (demonstrated that a substantial quantity of products
was sold at the price noted or higher) and Time Test (necessitates products being sold at the regular
price for a substantial period of time)
- Bait & Switch – a deceptive practice of luring customers into the store with a very low advertised
price on an item (the bait), only to aggressively pressure them into purchasing a higher-priced item
(the switch) by disparaging the low-priced item, comparing it unfavourably with the higher-priced
model, or professing an inadequate supply of the lower-priced item.
- Loss Leader Pricing – takes the tactic of leader pricing one step further by lowering the price below
the store’s cost.
2. Predatory Pricing – when a firm sets a very low price for one or more of its products with the intent
to drive its competition out of business. Illegal. Difficult to prove, must be 1. Intent to drive out
competition, and 2. The complainant must prove that the firm charged prices lower than its average
cost
3. Price Fixing – practice of colluding with other firms to control prices. Bread thing.
Horizontal Price Fixing – competitors at the same level collude
Vertical Price Fixing – parties at different levels collude.
Manufacturer’s Suggested Retail Price (MSRP) – manufacturers encourage retailers to sell their
merchandise at a specific price.
4. Price Discrimination – when firms sell the same product to different resellers at different prices, it
can be considered price discrimination; usually, larger firms receive lower prices. B2C is illegal, but
B2B, not necessarily.