Sequence of Steps in Generic Price Setting

ICU: INTRODUCTION TO MARKETING Vladimir V. Bulatov. [email protected]

Lecture 14. Pricing II.

SEQUENCE OF STEPS IN GENERIC PRICE SETTING.

1. Identify pricing objectives and constraints: objectives: profit, market share, survival, etc; constraints: demand, newness, costs, competition, etc.

2. Estimate demand and revenue.

3. Determine cost, volume, and profit relationships.

4. Select an approximate price level.

5. Set list or quoted price.

6. Make special adjustments to the list or quoted price.

4. SELECTING THE APPROXIMATE PRICE LEVEL.

A. Demand-based methods. Skimming pricing (“skimming the cream of profit gradually from different market segments). Implemented by setting initially the highest price a certain portion of the market can accept, and then gradually decreasing the price to stay competitive. Necessary market conditions: - enough prospective customers are willing to buy the product immediately at the high initial price to make these sales profitable; - high initial price does not attract competitors (due, say, big R&D costs); - lowering price has only minor effect on increasing the sales volume and reducing the unit costs; - customers interpret high price as the indicator of quality.

Penetration pricing (setting low initial price to appeal immediately to the mass market). Necessary conditions: - many segments of the market are price sensitive; - low initial price discourages competitors to enter the market; - unit production and marketing costs fall dramatically as production volumes increase.

Prestige Pricing (setting a high price so that status-conscious consumers will be attracted and buy the product).

Price lining (pricing different product lines at different price levels). Necessary conditions: - demand is elastic at every price point, but inelastic in between them;

—1— Intro to Marketing. Pricing II - number of price points is limited to 3-5 (because bigger number of quantities confuse customers).

Odd-Even pricing (setting prices slightly below round numbers [e.g. 499,95], expecting that customers will see numbers as “below the round ones,” contrary to “approximately the round ones”). Necessary condition: - consumers must not reinterpret odd-even numbering as the indicator of low quality.

Demand-Backward Pricing (subtracting retailer’s and wholesalers’ revenue margins, manufacturer can calculate how much money remains for setting own profitable price). (Compaq made a 3 billion business during 2 years following this pricing approach).

Bundle Pricing (marketing several products in one package). (Based on the idea that consumers value the “package” more than individual items). (E.g. Microsoft Office costs consumer $750; however, if its content items would be purchased separately, the price would be $2190; such wholesale discount should attract customers, while the manufacture benefits from the economy of scale effect).

B. Cost-Based methods. Standard Markup Pricing (when the number of products is significant, demand estimation will outweigh any possible financial benefits; in this case product prices are formed by adding a fixed percentage to the cost of all items in a specific product class). (Such method is often used in supermarkets, where expressive product variety is present). The lower is the channel of distribution (wholesaler  retailer) the greater usually is the cost markup.

Cost plus Percentage-of-Cost Pricing (adding fixed percentage to the production/construction cost). (E.g. architect’s fee is 13% of the construction cost of a house).

Cost plus Fixed Fee Pricing (when the cost cannot be exactly estimated, any supplemental expense is stated as fixed fee; e.g. despite the construction cost of space shuttle [which is to be fully compensated], a fee to McDonnell Douglas for its provision would be in any case $100.000.000).

Experience Curve Pricing (the method is based on the learning effect, which holds that unit price of a product declines by a certain percentage when production volume doubles). (e.g. if the estimated cost falls on 15% when volume doubles and initial price is $100, then 100th unit’s price will be $85, 200th - $72,25; etc. Since the tendency is mathematically tractable, then the price predictions can be made easily and precisely).

C. Profit-Based Methods. Target Profit Pricing .

Target Return-on-Sales Pricing (target profit, although simple, does not show how much effort must be spent to earn one; return-on-investment method, however, does, because it includes the volume of sales in the calculations).

—2— Intro to Marketing. Pricing II Target Return-on-Investment (profit must be a percentage of invested capital; since a significant number of variables is involved, electronic spreadsheets are better to use when this pricing method is applied [see Figure 15-6]).

D. Competition-Based methods. Customary pricing (in the environment where several competitive factors dictate a price [traditions, channel of distribution, etc], this pricing method is most applicable; e.g. all sellers offer candy bars at approximately $0.50).

Above-, at-, or below-market pricing (Rolex – above; known brands – at; unknown/new brands – below).

Loss-Leader Pricing (lowering price below cost for some products with the purpose of attracting customers and expecting them to purchase some other goods, which have a significant price markup).

Sealed-Bid Pricing (a significant volume of purchase is announced, and sellers/manufacturers are invited to propose offers; afterwards, all offers are evaluated and the winner with the best proposition is chosen).

5. SET THE LIST OR QUOTED PRICE. One-price vs. flexible price policy. (Stated vs. negotiable prices).

In strategic perspective, all costs must be covered and (unless the org. is non-profit) profit must be generated.

Incremental costs must be offset by incremental revenues (any extra expenditures must be offset by extra surplus).

Company, customer, competitive effects. Company effects: e.g. pricing the products the way not to cause cannibalization. Customer effects: e.g. customer psychology [e.g. pricing not below 20-25% of brand manufacturers for unknown products]. Competitive effects: e.g. potential price responses from competitors must be anticipated.

6. MAKE SPECIAL ADJUSTMENTS TO THE LIST OR QUOTED PRICE. Discounts (quantity; seasonal; trade [functional] – e.g. lower prices for agents and wholesalers; cash discounts).

Allowances. Trade-in allowance: reduction of the product price when old version of the product is brought back to the seller. Promotional allowance: either actual cash payments or extra free goods for undertaking certain advertising or selling activities.

Geographical Adjustments Non-uniform and uniform geographical pricing. INCOTERMS conditions affecting the final price.

Legal and regulatory aspects: read in the book.

—3— Intro to Marketing. Pricing II