Marketing Management MKT 600 Price in Mktg Mngnt

Marketing Management MKT 600 Price in Mktg Mngnt & pricing strategy

Pricing Decisions Lecture Overview § § Introduction Theory of Pricing Objectives Strategic Determinants of Price §Costs §Demand §Competition § Positioning of Life Cycles § Pricing Strategies §Market skimming §Market penetration §Destroyer pricing §Promotional pricing 2

INTRODUCTION All products and services have a price just as they have value. Many non-profit and all profit-making organisations must also set prices, be they; the price to see a consultant doctor or to buy a pair of trainers or a price to visit the island where Princess Diana lies. Pricing is a measure of what a product is worth in that it sets a value for a product and service – but it also goes under many names. For example, § Rent for your flat § Tuition for your education § Fee to see your dentist § Airline, bus and taxi firms charge a fare § A guest lecturer charges an honorarium § Clubs and societies charge subscriptions § Lawyers may ask for a retainer Definition - ‘Price is the sum of all the values that consumers exchange for the benefits of having or using the product and service. ’ 3

Probably the single most important decision in marketing is price, in that economists will agree that price directly affects sales volumes. If a price is too high and the market competitive, sales will fall. On the other hand, many marketers have found ways to reduce the impact of price. In the case of non-profit organisations there simply is no price (eg seeing a doctor) and as such may not be applicable. On the other hand, some principles can still be applied if ‘price’ is replaced by the ‘perceived value’ to the customer. In this way the customers put a value (often a high value) on the service, and this can be dealt with much as price is itself. 4

THEORY OF PRICING Much of theory of pricing is derived from that of economics. The basic idea is that, ‘Demand will be different at each price level chosen’ As can be seen from the diagram, demand normally (but not always) falls as price increases. Price Demand curve Quantity demanded 5

Alternatively, supply normally increases as prices rise (the reverse of demand), gaining the supply curve (see below). Price Supply curve Quantity supplied 6

In theory, prices changed will be set such that demand supply are equally balanced, such that demand = supply. This point is called the equilibrium price, as shown below. Price Supply £ Equilibrium Price Demand Quantity 7

The problem with economic theory is it discounts to a great extent. The fact that buyers today are no longer restricted to buying essentials but can indulge in choice products, including luxuries. The suppliers of these products differentiate them (via the marketing mix) such that they can be more flexible with their pricing. Price Elasticity of Demand – Different markets for products ad services have different levels of sensitivity towards the prices changed. The degree to which demand is sensitive to price is called ‘price elasticity of demand’. Definition - Price elasticity of demand is the percentage change in the quantity of a good demanded, divided by the corresponding percentage change in its price, or price elasticity of demand 8 = change of demand (%) change of price (%)

In the commodities market, for example, where products such as; salt, cement, oil etc are often undifferentiated, the demand for your product will be very dependent on the price you seek. Where a company sets it commodity prices above the market price it is unlikely to sell its product. Here the products price is said to be elastic. At the other end of the spectrum there are products that are very insensitive in terms of price. These products or services are often highly differentiated such that the market is willing to pay a higher price. Products and services are often branded to reflect this differentiation and so claim a premium price. Demand for such products/brands are often called ’price inelastic’. 9

PRICING OBJECTIVES § Survival – Under service competitive pressure, in order to survive companies will cut prices to the extent they do not cover all their costs – so long as it generates cash to keep the company going. § Profit Maximisation – In the long-term all companies must make profits otherwise their future will be uncertain. § Sales Maximisation – Generating lots of sales can lead to reduced unit costs and so make the company more profitable as well as dominant in its market sector. § Price competition – A competitive price is not necessarily the lowest price, but it is one that gives the company a competitive advantage in the marketplace. For example, Gillette razor blades are often priced higher than their competitors because they are perceived to provide a much higher quality than their competitors. This quality leadership means they can change and are expected to change to a higher price. Rolls Royce cars are expensive products that maintain their competitive edge in international markets because of the combination of benefits offered through the marketing mix, including a high price. 10

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STRATEGIC DTERMINANTS OF PRICE There are 3 major influences on pricing decisions. These are Cost Demand Competition Costs The quantity of products sold ( ie sales volume) is a critical factor in the success of any business. The reason is that every business has to pay 2 different kinds of costs associated with sales, fixed costs and variable costs. Types of Costs §Fixed Costs – Are so called because they remain the same mo matter how many units of product are sold. (Such costs include; rent, rates, heating, lighting, wages, depreciation, insurance etc. ) §Variable Costs – Are those that vary directly according to the number of units produced/sold. (Such costs include; materials and components, machine running time etc) 12

The difference between the variable cost per unit of product and the price paid by the customer is called the margin. While the rates of variable costs to the margin remains constant no matter how many units are sold, the rates of fixed costs to margin changes with the number of units sold. For example; If your fixed costs are £ 1000 a year and you sell 100 units, then each unit will gave to carry £ 10 of fixed costs. If on the other hand you sell 500 units then each unit only has to carry £ 2 of fixed costs which makes a big difference when you come to price the product. Cost Plus Pricing – The vast majority of firms price their products based on mark up on the cost providing the product or service concerned. The reason it is simple to calculate is information on costs are often well defined by accountants so firms simply add a margin to the unit cost. The unit cost is the average cost of each item produced. If a firm produces 800 units a total cot of £ 24, 000 the unit cost will be £ 30. many small businesses will tell you they ‘cost out’ each hour worked and then add a margin for profits. For example, fashion clothes sold by retailers are marked up between 75 -150%. The process if cost plus pricing can best be illustrated in relation to large firms where economies of scale can be spread over a considerable range of output. Whilst very popular, there are dangers attached. If the price is set too high, a sale will be lost; if set too low, profit will be lost. 13

Firms that operate in international markets tend to favour cost-plus pricing because it involves using a simple formula rather than having to calculate the relative strength of demand in lots of quite different markets. However, if this method is applied too rigidly, it can cause problems in the marketplace. For example, if demand is lower than expected, unit costs may be slightly higher. In this case the accountants may well seek to raise prices. This will in turn make sales even harder to achieve. If on the other hand, demand is higher than expected, unit costs may fall and a price reduction may be sought which could lead to loss of revenue and profit. 14

Contribution Pricing – This involves separating out the different product that make up a company’s portfolio in order to change individual prices appropriate to a product’s share in total costs. We have already identified the 2 broad categories of costs: variable (direct) costs vary with the quantity of output produced or sold; fixed (indirect) costs have to be paid irrespective of the level of output or sales. While it is easy to attribute direct costs to products it is not always that simple to indirect costs, such as, wages, business, rent and rates etc. however, if we can identify the variable costs we can at least identify each products ability to cover its direct cost and assess how much is left over to contribute to fixed costs. Revenue from Product X – Direct variable costs = Contribution of X Revenue of Product Y – Direct variable costs = Contribution of Y The total of all the contribution should cover all the fixed costs. Any balance is called the profit. Contribution is an excellent way of pricing for firms selling to a range of international markets which share a common fixed cost base. 15

Demand orientated pricing involve reacting to the intensity of demand for a product, so that high demand leads to high prices and work demand ti low prices, even though unit costs are similar. When a firm can segment its market into different groups, it can carry out a policy of price discrimination. This involves selling at high prices in segments of the market where demand is intense (ie where demand is inelastic and at relatively low prices where demand is elastic. Customer Orientated Discrimination – Customers are often willing to pay a high price when something is new. They also have an expectation of what price to pay. Therefore, firms can, and often do, charge different prices for the same product at different times and in different locations. For example, many boos are initially sold in hardbook at a high price, but when the innovator section of the market is satisfied, a cheaper paperback version is released at a lower price to attract other market sectors. Time Orientated Discrimination – Demand for a service or product can vary by season or even the time of day. At these peak demand time, products/service are often charged at a high price and at off peak time at a lower price. This applies to a wide variety of items from fashion clothes to train and air services. 16

Product Orientated Discrimination – Slight modification to products can allow for high and low price strategies. For example, many car models have additional extras (eg 2 or 4 door version, with or without sunroof etc). Customers have a choice of the cheaper basic model or a more expensive version. Situation Orientated Discrimination – Products or services can change more or less based on their situation or location. For example, demand for houses can very dependant on the location of the house, cinema and theatre seats may be priced according to their proximity to the screen or stage. 17

Competition The nature and extent of competition is frequently an important influence on price. If forced by direct competition, then the product will compete against very similar products in the marketplace and as such with little differentiation prices will need to be I line with rival prices. In contrast, when a product is faced with indirect competition (ie competition with products in different sectors of the market) then there will be more scope to vary price. For example, a firm may choose a high price strategy to give a product or brand a ‘quality’ feel. In contrast, it might change a low price so that consumers view the product as a bargain. 18

However, Hatton and Oldroyd have shown there is a price floor and a price ceiling in which marketers can set prices, as shown below - Price Ceiling Demand What the market will Competitors Price Range Costs Price Floor Within this band, there may be avoid retaliatory responses. agreement between competitors (eg petrol/cigarettes) to 19

POSITIONING AND LIFE CYCLES The price a company sets impacts on the position of its products the competition in terms of quality. It may be necessary to change the price of a product as it moves through its life cycle and hence needs to be repositioned. § Introduction - High performance costs – high prices § Growth - High performance costs but also sales growth – prices become more competitive. § Maturity - Lower promotional costs – Sales growth slow, profit taken, prices stabilise at level determined by market share/volume/demand relationships. § Decline - Minimal promotional costs Sales decline Prices reduced 20

PRICING STRATEGIES Pricing can be used as an in tool to pursue short term marketing and selling targets for a company. Typical attack based policies/strategies include – §Skimming pricing §Destroy pricing §Penetration pricing §Promotional pricing Market Skimming – Often used when launching anew product into a market where there is little direct competitions in the market so demand for the product may be somewhat inelastic. Skimming involves setting a relatively high (or very high) initial price in order to yield high returns from the consumers willing to buy the product as shown below - First layer of customers Second layer Third layer etc 21

Market Penetration – This method offers low prices to attract large numbers of customers and so gain market share by penetrating the existing market. The method works best where demand is relatively elastic and increased sales can have a great effect on reducing the unit cost per sale. § § High fixed costs Demand elastic Economies of scale Lots of customers Penetration pricing A typical example would be a new breakfast cereal or a product overseas market. Leads to increased sales and market share launched in a new Initially it would be launched with a relatively low price, coupled to discounts and special offers. As the product penetrates the market, sales and profitability increase. Prices can then creep upwards. 22

Destroyer Pricing – This policy can be used to undermine the sales of rivals or to warn potential new rivals not to enter the market. Destroyer pricing involves reducing the price of an existing product at an artificial low price in order to destroy competitor sales as shown below – Price Natural Market Price Destroyer price range Price which yields lowest acceptable long -term return on capital invested When entered the UK market in the mid 90 s, British supermarkets slashed their prices in the localities close to the new stores in an attempt to kill off the American rival. Supermarkets continue to practice similar tactics in their local business environments in order to close down the number of local independent traders around them. 23

Promotional Pricing – This policy is used to inject fresh life into an existing product or to create new interest in a new product. It can help to increase the rate at which the product is turned over, which can reduce stock levels. Loss leaders are products whose price has been reduced in order to boast its sales, but also the sales of products closely associated to it. 24