Marketing Management

Companies pursue survival as their major objective if they are plagued with overcapacity, intense competition, or changing consumer wants. As long as prices cover variable costs and some fixed costs, the company stays in business. Survival is a short-run objective; in the long run, the firm must learn how to add value or face extinction.

(Kotler 389)

Many companies try to set a price that will maximize current profits. They estimate the demand and costs associated with alternative prices and choose the price that produces maximum current profit, cash flow, or rate of return on investment. This strategy assumes the firm knows its demand and cost functions; in reality, these are difficult to estimate. In emphasizing current performance, the company may sacrifice long-run performance by ignoring the effects of other marketing variables, competitors' reactions, and legal restraints on price.

(Kotler 389)

1. Selecting the Pricing Objective

2. Determining Demand

3. Estimating Costs

4. Analyzing Competitors' Costs, Prices, and Offers

5. Selecting a Pricing Method

6. Selecting the Final Price

(Kotler 389)

Some companies want to maximize their market share. They believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest price, assuming the market is price sensitive. Texas Instruments (TI) famously practiced this market-penetration pricing for years.

The following conditions favor adopting a market-penetration pricing strategy: (1) The market is highly price sensitive and a low price stimulates market growth; (2) production and distribution costs fall with accumulated production experience; and (3) a low price discourages actual and potential competition.

(Kotler 390)

Companies unveiling a new technology favor setting high prices to maximize market skimming. Sony is a frequent practitioner of market-skimming pricing, in which prices start high and slowly drop over time.

(Kotler 390)

A company might aim to be the product-quality leader in the market. Many brands strive to be "affordable luxuries"—products or services characterized by high levels of perceived quality, taste, and status with a price just high enough not to be out of consumers' reach. Brands such as Starbucks, Aveda, Victoria's Secret, BMW, and Viking have positioned themselves as quality leaders in their categories, combining quality, luxury, and premium prices with an intensely loyal customer base.

(Kotler 390)

Each price will lead to a different level of demand and have a different impact on a company's marketing objectives. The normally inverse relationship between price and demand is captured in a demand curve (see Figure 14.1): The higher the price, the lower the demand. For prestige goods, the demand curve sometimes slopes upward.

(Kotler 390)

The demand curve shows the market's probable purchase quantity at alternative prices. It sums the reactions of many individuals with different price sensitivities. The first step in estimating demand is to understand what affects price sensitivity. Generally speaking, customers are less price sensitive to low-cost items or items they buy infrequently. They are also less price sensitive when (1) there are few or no substitutes or competitors; (2) they do not readily notice the higher price; (3) they are slow to change their buying habits; (4) they think the higher prices are justified; and (5) price is only a small part of the total cost of obtaining, operating, and servicing the product over its lifetime

A seller can successfully charge a higher price than competitors if it can convince customers that it offers the lowest total cost of ownership (TCO). Marketers often treat the service elements in a product offering as sales incentives rather than as value-enhancing augmentations for which they can charge. In fact, pricing expert Tom Nagle believes the most common mistake manufacturers have made in recent years is to offer all sorts of services to differentiate their products without charging for them.

Of course, companies prefer customers who are less price-sensitive. Table 14.3 lists some characteristics associated with decreased price sensitivity.

On the other hand, the Internet has the potential to increase price sensitivity.

(Kotler 390-391)

Price elasticity depends on the magnitude and direction of the contemplated price change. It may be negligible with a small price change and substantial with a large price change. It may differ for a price cut versus a price increase, and there may be a price indifference band within which price changes have little or no effect

(Kotler 392)

Also known as overhead, are costs that do not vary with production level or sales revenue. A company must pay bills each month for rent, heat, interest, salaries, and so on regardless of output.

(Kotler 393)

Vary directly with the level of production. These costs tend to be constant per unit produced, but they're called variable because their total varies with the number of units produced.

(Kotler 393)

Consist of the sum of the fixed and variable costs for any given level of production.

(Kotler 393)

The cost per unit at that level of production; it equals total costs divided by production. Management wants to charge a price that will at least cover the total production costs at a given level of production.

(Kotler 393)

Given the customers' demand schedule, the cost function, and competitors' prices, the company is now ready to select a price. Figure 14.4 summarizes the three major considerations in price setting: Costs set a floor to the price. Competitors' prices and the price of substitutes provide an orienting point. Customers' assessment of unique features establishes the price ceiling. Companies select a pricing method that includes one or more of these three considerations.

Six Price-Setting Methods:
markup pricing, target-return pricing, perceived-value pricing, value pricing, going-rate pricing, and auction-type pricing.

(Kotler 395-396)

1. Markup Pricing

2. Target-Return Pricing

3. Perceived-Value Pricing

4. Value Pricing

5. Going-Rate Pricing

6. Auction-Type Pricing

The most elementary pricing method is to add a standard markup to the product's cost.

EXAMPLE = Lawyers and accountants typically price by adding a standard markup on their time and costs.

Markup price = Unit Cost / (1-Desired Return on Sales)

Markups are generally higher on seasonal items (to cover the risk of not selling), specialty items, slower-moving items, items with high storage and handling costs, and demand-inelastic items, such as prescription drugs.

Does the use of standard markups make logical sense? Generally, no. Any pricing method that ignores current demand, perceived value, and competition is not likely to lead to the optimal price. Markup pricing works only if the marked-up price actually brings in the expected level of sales.

Still, markup pricing remains popular. First, sellers can determine costs much more easily than they can estimate demand. By tying the price to cost, sellers simplify the pricing task. Second, where all firms in the industry use this pricing method, prices tend to be similar and price competition is minimized. Third, many people feel that cost-plus pricing is fairer to both buyers and sellers. Sellers do not take advantage of buyers when the latter's demand becomes acute, and sellers earn a fair return on investment.

(Kotler 396-397)

The firm determines the price that yields its target rate of return on investment.

Target-Return Price -
= Unit Cost +[(Desired Return × Invested Capital)/Unit Sales]
=$16 +.20 × $1,000,00050,000=$20

Break-Even Volume -
= Fixed Cost(Price-Variable Cost)
=$300,000$20-$10=30,000

But much depends on price elasticity and competitors' prices. Unfortunately, target-return pricing tends to ignore these considerations. The manufacturer needs to consider different prices and estimate their probable impacts on sales volume and profits.

The manufacturer should also search for ways to lower its fixed or variable costs, because lower costs will decrease its required break-even volume.

(Kotler 397-398)

An increasing number of companies now base their price on the customer's perceived value. Perceived value is made up of a host of inputs, such as the buyer's image of the product performance, the channel deliverables, the warranty quality, customer support, and softer attributes such as the supplier's reputation, trustworthiness, and esteem.

Companies must deliver the value promised by their value proposition, and the customer must perceive this value. Firms use the other marketing program elements, such as advertising, sales force, and the Internet, to communicate and enhance perceived value in buyers' minds.

The key to perceived-value pricing is to deliver more unique value than the competitor and to demonstrate this to prospective buyers. Thus a company needs to fully understand the customer's decision-making process.

The company can try to determine the value of its offering in several ways: managerial judgments within the company, value of similar products, focus groups, surveys, experimentation, analysis of historical data, and conjoint analysis.56 Table 14.4 contains six key considerations in developing value-based pricing.

(Kotler 398-399)

In recent years, several companies have adopted value pricing: They win loyal customers by charging a fairly low price for a high-quality offering. Value pricing is thus not a matter of simply setting lower prices; it is a matter of reengineering the company's operations to become a low-cost producer without sacrificing quality, to attract a large number of value-conscious customers.

(Kotler 399-400)

An important type of value pricing is everyday low pricing (EDLP). A retailer that holds to an EDLP pricing policy charges a constant low price with little or no price promotions and special sales. Constant prices eliminate week-to-week price uncertainty and the "high-low" pricing of promotion-oriented competitors.

In high-low pricing, the retailer charges higher prices on an everyday basis but runs frequent promotions with prices temporarily lower than the EDLP level.60 These two strategies have been shown to affect consumer price judgments—deep discounts (EDLP) can lead customers to perceive lower prices over time than frequent, shallow discounts (high-low), even if the actual averages are the same.

EDLP provides customer benefits of time and money.

(Kotler 400-401)

In going-rate pricing, the firm bases its price largely on competitors' prices. In oligopolistic industries that sell a commodity such as steel, paper, or fertilizer, all firms normally charge the same price. Smaller firms "follow the leader," changing their prices when the market leader's prices change rather than when their own demand or costs change. Some may charge a small premium or discount, but they preserve the difference.

Going-rate pricing is quite popular. Where costs are difficult to measure or competitive response is uncertain, firms feel the going price is a good solution because it is thought to reflect the industry's collective wisdom.

(Kotler 401)

Auction-type pricing is growing more popular, especially with scores of electronic marketplaces selling everything from pigs to used cars as firms dispose of excess inventories or used goods. These are the three major types of auctions and their separate pricing procedures:

English auctions (ascending bids) have one seller and many buyers.

Dutch auctions (descending bids) feature one seller and many buyers, or one buyer and many sellers. In the first kind, an auctioneer announces a high price for a product and then slowly decreases the price until a bidder accepts. In the other, the buyer announces something he or she wants to buy, and potential sellers compete to offer the lowest price.

Sealed-bid auctions let would-be suppliers submit only one bid; they cannot know the other bids. The U.S. government often uses this method to procure supplies. A supplier will not bid below its cost but cannot bid too high for fear of losing the job. The net effect of these two pulls is the bid's expected profit.

(Kotler 401-402)