Meaning of Price • Five Cs of Pricing • Ways to Change Prices

BUAD 307—Price Lars Perner, Instructor

PRICE

• Meaning of price • Five Cs of pricing • Ways to change prices • Legal issues in pricing • Price discrimination • Other pricing strategies • Customer price response • Category management

BUAD 307 PRICE Lars Perner, Instructor 1

Background. Pricing decisions are extremely important for the firm. Some of the reasons:

• Pricing is the only part of the marketing mix which brings in revenue. • Once a price has been set, consumers will often show a great deal of resistance to any attempts to change it. • Pricing frequently has important implications for the positioning of a product. • Price is the marketing mix variable for which a competitive response can be most quickly implemented.

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LEARNING OBJECTIVES

• Identify advantages and disadvantages of pricing approaches under different circumstances • Identify illegal and potentially unethical pricing practices • Identify differences in perspectives to price between marketing professionals and economists • Identify likely customer response to different price offerings • Identify degrees of product substitutability and implications for category management

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Learning objectives are indicated above.

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PRICE

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These are some topics covered.

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One View of Price

• Price = • Ways to change the price: resources given up – Sticker price (dollar ______amount) goods received – Quantity—same sticker price but lesser quantity • E.g., 12 bullets for – Quality—use of $6.00 = $0.50 per lower cost bullet materials—e.g., “gooeye” stuff rather than chocolate in candy – Terms • E.g., support, accessories, payment terms, delivery

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A logical examination suggests that price should be defined as

That is, we need to consider the quantity you receive as well as the amount of money you have to fork out. To say that gasoline costs $1.29 is meaningless outside the context that this cost is per gallon.

The above conceptualization suggests that the marketer has several ways available to change price:

• Increasing or decreasing the "sticker price" of a product. • Increasing or decreasing the quantity of material received. As prices of chocolate increased in the 1970s, firms found it difficult to raise candy bar prices. Instead, they simply made them smaller. • Changing the quality of a product. Firms may cut back on services or dilute products more, possibly reducing or cutting out expensive ingredients. • Change the terms of a sale. Firms may begin charging for previously free delivery. In recent years, many software manufacturers have stopped providing free telephone support for their programs.

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Examples of Price Changes

• Cereal manufacturers put a smaller quantity of cereal in boxes • Paper towel manufacturers use fewer sheets per roll • Candy bar manufacturers use more “gooey” stuff (instead of costlier chocolate) • Some hamburger chains stop using tomato slices when prices spike • Software makers now charge for service (900 numbers or per minute charge) but, adjusted for inflation, sticker prices are lower in this later stage of the life cycle • Most airlines now charge for checking baggage and domestic meals

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The five Cs of pricing provide a framework for understanding a number of issues in price setting:

Company Objectives. Firms may like to see a certain rate of return in their investments or to make a certain margin on items they sell. They may also like to be able to charge a premium price. Note that such desired return levels may not be realistic. Often, one or more firms can charge a premium price if they provide what customers see as a superior product, or at least one that satisfies the special needs of a particular customer group. However, to collect this premium, a firm must either have a strong brand name or genuinely be able to deliver a product worth this premium.

Competition. A firm can choose to charge what competitors are charging, hoping to avoid a price war.

Customers. Customers differ in their price sensitivity and the prices they are willing to pay. Some seek mostly to get the lowest priced product, even if this may not offer the same quality as more expensive ones, and even if the product does not last as long. Some will pay a premium for higher quality and/or features to meet special needs. Finally, some are willing to pay prestige prices to get a brand with which some status is associated. Current Apple products tend to be priced this way, with competing brands with roughly comparable features selling for considerably less.

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Views of Consumers and Price Response

• Economics • Marketing – Assumed to have – Consumer knowledge perfect information of product quality and about prices is imperfect • Quality of all brands – Due to imperfect • Prices of each brand information, a higher at all locations price may sometimes – Elasticity: A “down- be used by consumers sloping” demand to infer greater quality curve means that a (Research suggests that higher quantity will be actual product quality as demanded when the rated by Consumer Reports accounts for price is reduced about 25% of product price differences among brands)

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Economists generally assume—quite unrealistically—that consumers have perfect information about: • The quality of all brands available. • The price charged by each retailer for each respective brand.

Economists contend that although these assumptions are unrealistic, they nevertheless yield accurate predictions.

In marketing, however, it is recognized that consumers are often hit with considerable information overload and that, in practice, finding out all this information can be quite difficult and costly. This results in certain phenomena: • In some cases, consumers will infer that a higher priced product is of higher quality. • Consumers have imperfect memories of prices previously observed and paid. • Consumers, in some cases, do not accurately compute prices. It has been found, for example, that many consumers will tend, without doing the calculations, to buy larger sized packages under the assumption that there will be a “quantity discount.” In fact, per unit costs for larger packages are often higher.

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Five Cs of Pricing

• Company objectives— • Customers note that these may – Customer perceived value – Demand curve pricing not be realistic! (individual and market price – Target profit pricing elasticity) – Premium pricing – Prestige pricing – Profit maximization (optimal (note that your costs price structure, if known) • Costs may not equal those of • Competition competitors or value to – Competitive parity customers!) – Status quo pricing – Types: • Variable • Channel members • Fixed – Authorized sellers – Break-even quantity – “Gray” markets (diversion) – Returns by product category and customer value—may need to take smaller margins on some products BUAD 307 PRICE Lars Perner, Instructor 7

The five Cs of pricing provide a framework for understanding a number of issues in price setting:

Competition. A firm can choose to charge what competitors are charging, hoping to avoid a price war.

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Does the consumer have the means (income and/or NO Limited potential wealth) to pay for premium for premium products across product priced sales categories? NO YES

Is the customer willing to pay YES a premium price across Better potential product categories? for premium priced sales

Note: Some customers may “trade up” in select product categories of special personal importance.

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To assess the extent to which a potentially more affluent segment may be willing to pay a premium price for a product thought to be superior, we first examine the income and resources of the segment in question. If, in fact, the segment is better able to afford higher priced products, we then examine the extent to which this market is willing to pay a premium price. This is usually a matter of degree, and percentage of more affluent customers willing to pay a premium may be smaller or larger.

Again, note that if you attempt to compete here, you must provide a product that is at least perceived to be significantly better.

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Cost and Pricing

• Your cost may not equal that of competitors or reflect value to customers – In some cases, larger margins can be sought. In others, one will have to settle for smaller ones. May need to offer unprofitable products to be credible as a full line supplier. – In some cases, a product is sold at little if any profit to make larger products on accessories and “consumables”—e.g., • Amazon Kindle  e-books and other digital content • Printers  cartridges and toner • In the long run, you will generally need to cover at least your costs across products produced • However, meeting cost should generally used as a test only after price has set based on market conditions. Merely having higher costs does not allow a firm to charge higher than market prices. BUAD 307 PRICE Lars Perner, Instructor 9

So-called “cost-plus” pricing whereby a fixed percentage margin is added to the cost of producing or buying a product is generally not an appropriate pricing method. A firm’s costs may not reflect the costs of competitors or the actual value provided to customers.

In the long run, a firm will generally need to be able to cover its cost of offering a product. If this is not possible and the product is not one used to facilitate sales of other products that are profitable, it would make sense to exit the market.

In some cases, manufacturers choose to sell some products near, at, or below cost in order to make other sales that are profitable possible. When Amazon sells its Kindle tablet, for example, it becomes possible to sell digital content (e.g., books, video, music). When a printer manufacturer sells a printer, there will be a demand for consumables.

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Supply, Demand, and Quantities Supplied and Demanded

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Economists talk about supply and demand curves. These curves reflect the quantity demanded and supplied at various price points. An equilibrium will occur where the two curves intersect. This equilibrium will reflect both a price and a quantity sold.

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Supply, Demand, and Quantities Supplied and Demanded

• Supply: The “schedule,” or “curve,” of quantities supplied by the sellers at various prices offered by buyers – Tends to increase with price—a greater quantity will be supplied at a higher level of incentive to produce – Demand: The “schedule,” or “curve,” of quantities demanded by the buyers at various prices offered by sellers – Tends to decrease with Demand curve: Smaller price—the marginal value quantity at higher price of additional quantity tends to decline with a greater price – Occasionally, higher prices may lead to higher quantity demanded due to a possible “signal” of quality Supply curve: Greater quantity at higher price BUAD 307 PRICE Lars Perner, Instructor 11

Demand curves are generally “down” sloping. The higher the price, the less quantity customers are willing to buy. In some cases, however, a low price may signal—whether correctly or not—low quality to customers. Thus, demand may actually go down once a price goes below what is needed to believe that good quality is provided.

Supply curves are generally “up” sloping. The higher the price, the more sellers will supply. In some cases, they may be willing to switch to costlier supplies and to pay higher labor costs if they can sell for prices making these cost effective.

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Equilibrium

• The intersection of the supply and demand curves—neither Equilibrium side is interested in buying or selling more or less given the resultant market prices – This equilibrium may be temporary and may change once the market changes— e.g., • Changes in the availability  change in supply • Changes in cost of production  change in supply • Availability of new substitutes  change in demand

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A supply/demand equilibrium may be temporary in nature. Consumer demand may increase if certain items increase in popularity. Demand may decrease if new substitutes become available. Similarly, changes in total supply (e.g., depending on the harvest of a crop in a particular year) or cost of production will affect supply.

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Quantities Supplied and Demanded

• Quantity supplied: The quantity that will Equilibrium be supplied (sold) by price sellers at a given price point • Quantity demanded: The quantity that will be demanded (bought) by buyers at a given price point Equilibrium quantity supplied and demanded

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The terms “supply” and “quantity supplied” have distinct meanings. “Supply” refers to the entire supply curve. In contrast, “quantity supplied” refers to a specific point on the curve.

At any one curve, a certain quantity will be supplied the given price. As the price offered is increased or decreased, the quantity supplied (offered) will also change.

“Demand” and “quantity demanded” are similarly distinguished.

Note that two competing forces are present in determining the quantity that will be supplied at a given price. Firms will be willing to supply a larger quantity at a higher price. At the same time, when there is a potential to sell large quantities at a lower price, economies of scale may make it more attractive to offer this larger quantity at a lower price.

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Price Discrimination

• Explicit • Implicit – Only some customers are – No outright rule, but eligible for special discounted deal is unattractive to some pricing—e.g., customers • Student discounts on • Airlines: Saturday software night stay-over or • Senior citizen discounts advance purchase requirement • Geographic: Only customers • Daily special meal— in the 900**-935** zip code one cheaper meal but areas are eligible for no choice discount Disneyland • Periodic discounting Admission (products going on and off sale)

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Price discrimination is often employed in an attempt to get each customer group to pay the maximum that it is willing to pay for a particular product. There are two types of price discrimination:

• Explicit price discrimination involves a requirement that a customer must meet a special condition—such as being a student or a senior citizen—to get the lower price. • Implicit price discrimination does not expressly impose an eligibility requirement but makes it less attractive for certain customers to go for the lower priced alternative. Airlines, for example, often impose advance purchase requirements on airfares. This is often fine for leisure travelers who know well in advance when they will travel. It is, however, not attractive for business customers who may need to travel to see a client on short notice.

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“Upselling”

• An attempt to get the customer to upgrade to a more expensive option one a lower priced one has been selected—e.g., – Offer to upgrade to “Economy Plus” status on flights – Extra charge for preferred seat (e.g., aisle, extra space, front of plane) – Car rental upgrade

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“Upselling” refers to efforts to induce the customer to pay a higher price for an enhanced offering providing benefits not provided in the product offered at the regular price. Airlines, for example, offer customers the opportunity to upgrade to “Economy Plus” or a similarly named offering where the customer is given more space and possible other benefits such as early boarding or free baggage checkins. At the same time, airlines have now also offered lower priced “basic economy” fares that do not even allow for carry-on baggage.

Car rental firms may take a reservation for a particular car at a particular price and then offer the customer a “free upgrade” when he or she arrives to claim the car. Sometimes, however, the customer must pay to upgrade to some intermediate level (a car better than the one originally reserved but not as good as the one offered with the upgrade) before he or she can quality for the “free upgrade.”

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Add-on Options

• Collision waiver on rental cars • Flight insurance • Extended warranty options • “VIP package”

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Customers are sometimes offered the option to add on features to an original package. For example, car rental companies may offer customers a “collision waiver” whereby they will not be charged if damage is done to the vehicle. Airlines and/or ticket brokers may offer the customer flight cancellation insurance where the fare may be refunded if the customer has to cancel the trip for an acceptable reason (e.g., a medical situation).

Some retailers of electronics products make a large part of their profits from “extended warranties” that they attempt to sell to customers. These plans typically increase the duration of the warranty and also increase the scope of coverage (e.g., covering damage to a computer even if accidentally dropped).

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Pricing New Products

• Skimming: high intro price ---> take advantage of price insensitive consumers – Initial sales volumes will be limited – High margins are likely to encourage competitors to enter and undercut your price – More effective when competitors cannot match your new offerings in the near future (e.g., newest Intel chips) • Penetration pricing: low intro price – Will usually result in higher sales volumes – Sales happen faster (less incentive to wait) – Competitors are less likely to enter and offer lower prices

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When new products are introduced, expected customer price sensitivity and the extent to which competitors can match your product offering should be considered.

In some cases, a firm may introduce a new product significantly better than what has previously been available. Some customers may value the new product so much that they are willing to pay a great deal more than those who are more price sensitive. A new chip from Intel, for example, may provide a highly coveted boost in processing power for those doing animation, gaming, or other processor intensive tasks. In the chart below, we see that different customers are willing to pay different amounts of money. The least price sensitive

segment is willing to pay a higher price (P1) than the other segments to get the new product immediately. The other segments do not value the new product as much and are not willing to pay as much. It may be possible, then, to charge the first segment more money, and then—potentially within a few months to a year—lower the price enough so that the next

segment will buy it (P2 in this illustration). The process continues until all segments that can be profitably served have bought.

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Skimming Pricing

350 Most price insensitive 300 customers P1 250 P2 Only a limited 200 Second most price quantity is sold at insensitive customers 150 the highest price P3 100

0 Q1 Q2 Q3 0 200 400 600 800 1000 1200

The product is introduced at a high price, P1. Very few customers—only the least price sensitive ones—buy at this price. When the price is later

lowered to P2 and then to P3, other customers who value the product less will start to buy. The least price sensitive customers pay a premium for quick access to the new product.

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Since customers differ in how much they are willing to pay for a product, it is possible to make large margins on the more price inelastic segments. For example, Intel tends to charge high prices for its most recent chips, gradually lowering prices as a new generation is introduced.

Note that the “skimming” approach is highly vulnerable to competition. If a competitor sees you making “supernormal” profits, it will likely try to undercut you if it can offer a similar product. Others, in turn, will then gradually introduce products at progressively lower prices until prices and profits have reached normal levels. The skimming approach, therefore, generally only works when one firm has at least a short term monopoly on the premium

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market.

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Penetration Pricing

350

300 A large quantity is 250 sold early on due to Some customers would the lower price be willing to pay a P1 200

higher price than what 150 they actually pay under this low introductory 100 price(area between the 50 green curve and the red line) 0 Q1 0 200 400 600 800 1000 1200

The product is immediately introduced at a relatively low price (and will continue to be sold at a low price.) The seller sacrifices the higher margins that would have resulted from selling to some customers at a higher price, but, in return gains immediate sales. Fewer competitors are attracted into the market since the apparent profits are not as high. Because of economies of scale and experience curves—the tendency of production costs to decline with the cumulative production—costs are reduced. BUAD 307 PRICE Lars Perner, Instructor 19

Alternatively, firms may choose the "penetration" pricing strategy. This strategy also takes advantage of price elasticity and attempts to dramatically boost the number of units sold early on by offering the product at a low price.

Since costs of production tend to go down as cumulative production increases, this strategy may be effective. Penetration pricing is also useful when a firm wishes to establish a large market share early on, and it may be useful to develop a market for accessories to products. For example, a manufacturer of a new computer system may want to increase sales volumes in order to encourage the development of compatible software so that the computer brand will offer greater value. Note that "skimming" and penetration pricing involve tradeoffs. A clearly preferred strategy may not be obvious, and managers may need to engage in some serious consideration to arrive at a desired strategy. Both strategies involve some level of risk. The main risk to "skimming" is the attraction of aggressive competitors who see an opportunity to make large profits by entering. Penetration pricing, in contrast, gambles on the possibility that sales volumes will in fact increase with lower prices. 19 BUAD 307—Price Lars Perner, Instructor

Some Approaches to Pricing, Part I

• Cost-plus: Add fixed percentage markup (in practice, this does not necessarily reflect the actual value to your customers) • Buyer-based

• Perceived value Preferred method when • Going-rate (matching the market price) an offering is differentiated from • Supply and demand results in an those of competitors equilibrium price for product categories with limited differentiation

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Pricing strategies can be categorized based on several different variables. One variable of interest relates to the consistency of the prices. Some retailers today attempt to follow a strategy of "everyday low pricing." Although few firms tend to practice this method with perfect consistency, certain retailers like Walmart tend to focus on providing constant low prices putting products on and off sale. Because a lower charged when a product is put on sale is often funded by the manufacturer rather than the retailer, everyday low price retailers will, in practice, tend offer some products on sale to take advantage of the manufacturer’s promotion.

Other retailers instead feature prices which, when not discounted, are somewhat higher. To compensate, periodic sales feature price reductions. Sales can be implemented either with a predictable pattern (e.g., a product is put on sale every fourth week) or in a random manner (e.g., in any given week, there is a 25% chance that the product will offered on sale

Note that "high-low" and "everyday low price" strategies are intended to take advantage of different price elasticities across people. Some consumers are price sensitive and will tend to buy only during sales; other people, in contrast, will buy all the time. Thus, people who are not willing to switch brands will have to pay full price for your products when they are not on sale; while they are on sale, a large number of "switchers" are attracted and sales volumes are increased.

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Some Approaches to Pricing, Part II

• Everyday Low Price (EDLP)—low everyday prices but no sales (difficult in practice since manufacturers often pay for lower sale prices) • High/Low Pricing: Higher regular prices with periodic sales

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Two other concepts are worth noting. A "cost-plus" pricing strategy entails marking up the estimated cost of producing a product by a certain, fixed percentage. In contrast, pricing based on consumer perceived value keeps the firm in closer proximity to the market.

In general, simple "cost-plus" pricing is inappropriate because:

• Your costs, in a market which is not perfectly competitive, may not be reflective of the costs of your competitors. If theirs are lower than yours, you may be over pricing your products; if it is higher than yours, you may be able to charge higher prices than cost-plus would suggest. • Your costs are not reflective of the value of the product to consumers. • The prices of some products are more salient than those of others; thus, you may want to use some products as "loss leaders." • Understanding the relationship between price and quantity demanded as well as the cost of producing this quantity will help make decisions on pricing and quantity produced. In this context, note the effects of experience previously discussed in the text. That is, it may be profitable to sacrifice margin immediately to move along the experience curve and enjoy a cost advantage relative to competitors later.

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Legal Issues

• Banned by Federal law: • Banned by some state – Discrimination in prices laws: paid by firms which – Gender discrimination compete against each (e.g., charging more other unless supported for dry cleaning by evidence of cost women’s clothes than savings men’s clothes) • OK to charge restaurants – Discrimination more than grocery stores between consumers in • Can only charge Wal-Mart general less than Joe’s Supermarket • Senior citizen if volume savings can be discounts are proven—and the price explicitly permitted difference must be no in California greater than the actual provable cost savings.

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The United States maintains relatively stringent (by international standards) antitrust laws. Much of the rest of the World is catching up with us, but traditionally, anti-competitive laws in many European and Asian countries were either non-existent, intended to actively encourage collusion, or were not enforced. Antitrust issues relevant to prices can be categorized into the following main categories:

• Minimum prices: It is generally, with a few relatively complicated exceptions, illegal to sell products below your cost of production. (For firms holding a large market share, these costs, in accounting terms, must be "fully absorbed"—that is, overhead and development costs must be apportioned among products sold). • In selling to entities that compete against each other, price discrimination or volume discounts are generally only legal to the extent that a manufacturer can prove actual cost savings associated with serving a large account. The law provides that the manufacturer has the burden of proof to establish that cost savings exist. The prohibition on price discrimination generally applies only to entities competing against each other. This means that differences in prices charged by a firm to competing restaurants must be justified by demonstrable cost savings, but it may be legal to charge supermarkets different prices than those charged to restaurants.

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More Legal Issues

• Federal and State bans on: – Collusion (coordinating or even discussing prices with competitors) – Tying: Requiring the customer to buy one product to be allowed to buy another – Predation (offering temporary prices below cost of production to drive competitors out of business and then raising prices) • In general, fully absorbed average cost must be used—cannot use marginal cost – Using monopoly power in one market to “subsidize” new market

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Anti-competitive pricing: In general, collusion, or firms getting together to fix prices, is outright illegal in the U.S. (but not in all countries—it is sometimes legal, for example, in Switzerland). In the late 1980s and early 1990s, certain airlines were accused of fixing prices by communication through their computerized reservation systems. Most airlines settled the suit, agreeing to certain injunctions limiting this practice.

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Price Maintenance

• In 2007, the U.S. Supreme Court reversed the longstanding ban on explicit agreements between manufacturers that the branded product would not be sold below an agreed upon “floor” price – Although setting minimum retail prices for a brand reduces intra-brand competition (competition between different retailers selling the brand), some believe that minimum prices may encourage investment in service and brand building to the extent that competition between brands increases (inter-brand competition) – Manufacturers generally cannot enforce minimum price agreements on existing inventory, but they can “cut off” offending retailers • “Gray market” goods: Retailers in the U.S. generally have an absolute right to sell products that they have bought legally at a price lower than the suggested retail price. – Diversion: Legitimate retailers buy up extra quantity to be resold to unauthorized dealers and/or geographic shipment. (More details will be given under distribution).

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Price maintenance refers to the practice of encouraging a certain minimum resale price of products. In 2007, the U.S. Supreme Court reversed its previous holding and ruled in the case of Ledgin Creative Leather Products, Inc. v. PSKS, Inc. that it is not automatically (“per se”) illegal for manufacturers to require retailers to charge at least a certain minimum price to customers in order to be supplied. Courts may still decide, depending on the facts and conditions of a particular case, that certain minimum price agreements between manufacturers and retailers result in a “restraint of trade” in violation of the Sherman Act. This conclusion is, however, no longer automatic and has to be established through the “rule of reason.”

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Intra- vs. Interbrand Competition

• Intrabrand Competition: Competition among sellers of the same brand (e.g., Nike Store, Target, and Sports Chalet all sell Nike shoes) – Often focused on price, although retailers can compete on service as well • Interbrand Competition: Competition between different brands (e.g., Nike, Rebok, Adidas) – Both manufacturers and retailers may be involved – Price is one factor – If manufacturers are able to guarantee retailers a certain margin since other retailers will not undersell them, retailers may be motivated to invest in additional services for customers (e.g., salesperson training, in-store repair facilities)

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A theory asserted is that, under some circumstances, retail price maintenance may actually increase inter-brand competition, or competition among brands, since retailers will now have a greater incentive to provide services and make investments in brand building knowing that they will not be undersold by retailers not offering these services. Intra-brand competition— or competition among the retailers selling the same brand—is likely to be reduced, but it is argued that the non-price benefits of increased service may be more valuable to customers in some circumstances than being offered the lowest possible prices. In the U.S., manufacturers generally cannot prevent retailers from selling their inventory at a lower price than what has been contractually specified, but the manufacturer can stop selling to such discounting retailers without being in automatic violation. As a matter of pragmatics, only a modest percentage of manufacturers would actually want to enforce price maintenance today. Discounters have now become a major force in the economy and the source of large sales volumes

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Tying vs. Price Bundling

• Tying: Requiring a customer to buy a less popular item in order to be allowed to buy something more popular – Generally not legal – Involves effective use of monopoly power • Price bundling: Offering two complementary items at a lower price than the sum of the individual items (more likely to be equal) – E.g., hotel alone is $185 per night and care rental is $75 per day, but a special deal is offered of both for $225 per day ($35 saving) – May involve a third party combining offerings of two partner firms (e.g., hotel and car rental service)

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Tying: It is generally illegal to require a customer to buy a less desired product in order to allowed to buy a highly desired product in limited supply. In practice, it is difficult to decide where to draw the line. For example, most consumers would probably prefer to buy a cellular phone and charger together so it may not unreasonable, for the sake of expediency, to sell the phone only as part of a package that includes the charger. They key, here, is whether the customer is being asked to buy an abundantly available product in order to be allowed to buy a highly desired product in short supply.

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REMINDER

INCOME ≠ WILLINGNESS TO SPEND!

Income or wealth is a necessary, but not sufficient, condition for buying certain high price items.

Some customers may value one product category particularly highly.

Many consumers live beyond their means, running up large debts.

It generally makes more sense to segment on price sensitivity than on income or wealth

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Again, a higher income is not the same as willingness to spend it. Many consumers with limited incomes live above their means, and many with greater incomes below. It is more useful to segment on price sensitivity.

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Price Adjustments For and Discrimination Among Consumers

• Cars: List price – manufacturer discounts and rebates – dealer discount • Tuition: List price – scholarships – financial aid

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Occasionally, price adjustments may be made. A car may come from the manufacturer with a base price and adjustments for options. The manufacturer may then indicate a temporary sale or promotion. The dealer may post a further discount, after which the customer may be able to negotiate the price down.

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Introductory Effects

• In an experiment, laundry 1200 detergent was introduced at 1000 800 Low price $0.49 in one condition and $0.79 intro Units 600 in another sold High price 400 intro • After 8 weeks, price was raised to 200 $0.79 for low price intro 0 8 6 condition 1 Weeks • There were higher cumulative sales in high price intro Introducing a product at a low price without clearly indicating that this is a temporary price to encourage trial will likely create an image among customers that this is a “low priced” brand.

Coupons may help avoid sending this signal.

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When a new brand is introduced, customers may be uncertain of its quality and may make inferences based on its price. Thus, when a product is introduced at a low price, it may develop an image as a low priced one, and it may be difficult to raise this price.

A study showed that when a brand of laundry detergent was introduced at a low price in half the stores in a drug store chain, sales were initially higher than in the other half of the stores where the product was introduced at a higher price. However, once the prices were raised to match those charged in the stores where the introduction was made at the higher price, sales went down below levels sold there. If consumers had acted with perfect information, as economists hypothesize, the sales should have hit the same levels across the two stores. That is, in the graph above, sales for both store conditions should have been at the level of the yellow marked line.

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Consumer Price Awareness

• A survey revealed of consumers who had just selected a product suggested: • Avg. time spent before departing from product area: 12 seconds • Avg. no. of products inspected: 1.2; only 21.6% claimed to check price of non- chosen brand • 55.6% could state price of just chosen product within 5%

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Research suggests a large segment of consumers does not give much attention to the prices of individual products. Consumers were found on the average to spend only about 12 seconds between arriving at the area within a store where a frequently purchased product was located and departing; on the average, consumers inspected only 1.2 products. Only 55.6%, seconds after having selected a product, could specify its price within 5% of accuracy. Note that this study does not indicate a total lack of consumer price sensitivity since consumers are undoubtedly making some inferences about the overall price levels of a store. Thus, the store has some incentive to maintain reasonable overall prices.

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Consumer Reference Prices

• Consumers typically have some expectation of what they will pay. This is based on: • Previous experience • Reasoning and “gut” feelings • Perceived fairness • Two kinds of reference prices: • Internal: Based on consumer’s memory. • External: Based on environment (e.g., signs, other products in the store)

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Consumers typically maintain reference prices for products. These are typically based on prices they have seen or paid in the past.

There are two kinds of reference prices:

• Internal reference prices are price expectations based on the consumer's experience. These are: • Often lower than actual retail prices; thus, consumers frequently experience "sticker shock" when shopping for certain products. • Frequently updated, but somewhat difficult to change dramatically. • Confined to a narrower range for some products than others. • External reference prices are prices supplied by a marketer as a means of influencing a consumer's price expectations—e.g., "Regularly $3.99; Now $2.99."

Research shows that both experience (prices previously paid) and the sale context (prices of competing brands) influence a consumer's internal reference price.

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Internal Reference Prices

• Consumers tend to develop some memory of prices of frequently purchased items ---> to make store prices look low, you may want to price especially salient products lower • More knowledgeable consumers typically have tighter price range expectations • Reference prices are constantly updated to some extent, but are hard to change upwards--certain unreasonable “stimuli” (prices) may be rejected as unreal • Consumer reference prices tend to be lower than actual prices ---> “sticker shock”

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Internal reference prices are those consumers typically carry in their heads in various ways. Certain products are purchased frequently, and therefore, the consumer is more likely to remember these. Supermarkets will often put frequently purchased items— such as yogurt—on sale. Since consumers cannot meaningfully process information about all prices offered, an impression of overall prices in the store will tend to be based on the more prominent items. Although other items are, individually, sold less frequently, total spending adds up.

Auto dealers are very vulnerable to the phenomenon of sticker shock. Because few people buy new cars more than once every few years, it has usually been considerable time since the last purchase when people go shopping. People are aware that there has been some level of inflation since the last time, but most are not aware of just how much. This puts considerable downward pressure on people’s willingness to pay, and heavy promotions and special deals are often needed.

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External Reference Prices

• Reference prices provided by seller or environment • E.g., • “MSRP $3.99; our price $2.49” • “Sold elsewhere for $20.00; our price $14.99” • “Was $100.00; now $69.95”

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External reference prices are provided by the manufacturer or retailer. Often, the “Suggested retail price” printed on a product is unrealistically high and more than even most full service merchants would charge. Thus, even full service retailers can come across looking good by selling “below retail.”

Other cues can be given to customers about what a product “ought” to cost under ordinary circumstances. These may be based on: • The “regular price” (which may not be what most customers actually pay since sales can be very frequent) • The previous price charged • What other retailers charge • Vague notions such as “Compare at.” These are often used by factory outlet stores but do not refer to anything specific. As such, they are likely to be misleading.

Research has shown that consumers tend to be skeptical about regular price claims. In a phenomenon known as the “discounting of discounts,” people often estimate “regular” prices to be proportionally less than what is suggested.

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The Promotion Signal

• A segment of consumers will respond to negligible discounts--e.g., “SALE! $3.95 (Was $4.02). • However, merely placing a sign “EVERYDAY LOW PRICE” randomly also increased sales of affected products.

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Some consumers will carefully evaluate whether a sale is sufficient in size to warrant the switching of brands or stocking up. One study found, however, that another segment of customers tended to look mostly at the “SALE” sign as a heuristic indicating that they would be getting a good deal. They were less affected by the actual side of the discount and would often switch based on a very small, or negligible, reduction.

One retail store manager claimed to have randomly put “everyday low price” tags by some products in his store. Since these items were randomly selected, on the average, these offered no greater value than the rest of the merchandise. Reportedly, sales of the “everyday low price” items increased significantly. This, however, is an anecdotal report that has not been confirmed by peer reviewed research.

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Other Manufacturers’ “Suggested” Retail Prices (MSRPs)

• U.S. manufacturers often put an exorbitantly high “suggested” price on a product so that even full service retailers can look good by selling below the MSRP • In some EU countries, selling below the MSRP is generally not legal— manufacturers must therefore be careful not to “recommend” excessive prices

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Manufacturers will often “suggest” retail prices so high that not even full service retailers would actually charge these. This makes even full service retailers look good by being able to “sell below retail.” In the U.S., these higher prices are entirely fictional; the manufacturer is not under the illusion that retailers would charge anything near these amounts.

Certain European countries, on the other hand, have laws intended to protect small “mom and pop” retailers that strictly limit the extent to which retailers may sell products at a “discount.” Sales may be permitted only during limited times of the year. In some cases, retailers may be stuck charging the MSRP even if this price is out of line with the prices charged for competing products.

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Odd/Even Pricing--Does It Have an Impact?

• Theory: $3.00 is rounded to $3.00 while $2.99 is rounded to “$2.00 plus change” • Reality: Studies in U.S. have found a small impact (the price elasticity is greater going from $5.00 to $4.95 than from $5.10 to $5.05). This is a very small impact. Sales increase only a slight amount. The loss of the extra cents may cancel out profit from increased quantity sales. • Note that odd pricing may signal receiving a bargain, which may nor may not be compatible with the desired product image • Odd pricing has typically been used by tradition (initially implemented to force cashiers to ring up purchases in order to give change).

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There is some question as to whether "odd" product prices (those ending in "9," "95," or "99) actually increase sales. Scanner data shows that there is a tiny effect of using odd prices. For example, the impact of lowering a price from $3.00 to $2.95 is likely to be slightly greater than the effect of lowering the price from $2.99 to $2.94, nearly the same percentage decrease. It should be emphasized, however, that this effect is very small.

Some retailers may use "odd" prices may emphasize the idea that you are receiving a bargain. This would be an appropriate strategy for retailers such as Walmart and Target, but not for Nordstrom’s, which prefers an image of high quality and high service. Note that these pricing patterns are intended to affect the price image of the retailer overall—i.e., that Walmart offers low prices consistently—rather than the perceived price of any one product.

REMINDER: The impact of “odd” prices is tiny!

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REMINDER

• The increase in sales that results from using “odd” prices is tiny!

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Many people miss questions on this issue. Scanner data suggests that the impact, although reliably detected, is very small.

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Category Management

• Pricing and promotion decisions are made with consideration of their impact on sales of other products that are potential substitutes – E.g., most of the increase in sales of Coca Cola that would result from a discount on or other promotion of that brand would likely come at the result of sales of Pepsi, other soft drinks brands, juices, and bottled water—the total increase in category sales will be much smaller • Some product categories have greater potential to increase total category sales if one brand is put on sale (e.g., total consumption of snacks can increase)

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Category management involves pricing and promotions based on the extent to which various items are common substitutes for each other. If Coca Cola is put on sale, sales of Coca Cola will increase considerably, but most of this increase will come at the expense of the sales of Pepsi. Thus, category sales will not increase, and since a large proportion of category sales are made with a heavy discount, profits will probably go down if the sale is funded by the retailer. (In practice, most price promotions of soft drink beverages are funded by the bottler, or manufacturer, who has different interests).

Other, non-cola types of soda compete to some extent with cola beverages, but less so. However, increased sales from discounted Coca Cola sales will come to some extent from the sales of these other beverages.

In other categories, the substitutability of potato chips for other types of snacks may be greater. The actual impact of discounts across these brands can be assessed by scanner data.