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Chapter 2 Pricing understanding and Customer value
Pricing Strategy (MM 302)
University of Southern Mindanao
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PRICING UNDERSTANDING AND
CUSTOMER VALUE
Learning objectives:
Define what is price and discuss the importance of pricing in today’s fast-changing environment Identify the three major pricing strategies and discuss the importance of understanding customer value perceptions, company costs, and competitor strategies when setting prices. Identify and define the other important external and internal factors affecting the firms pricing decisions.
Companies today face a fierce and fast-changing pricing environment. Value seeking customers have put increased pricing pressure on many companies.
What is price?
The amount of money charged for a product or service: the sum of the values that customers exchange for the benefits of having or using the products or services.
Price has been the major factor affecting the buyer’s choice. Price remains the most important elements that determine a firm’s market share and profitability.
Price is the only element in the marketing mix that produces revenue: all other elements represent costs. It is also one of the most flexible marketing mix elements. Unlike product features and channel commitments, prices can be changed quickly.
At the same time pricing is the number one problem facing many marketing executives, and many companies do not handle pricing well. Some managers view pricing as a big headache, preferring instead to focus on other marketing mix elements. However, smart managers treat pricing as a key strategies tool for creating and capturing customer value. Prices have direct impact on a firm’s bottom line. A small percentage improvement in a price can generate a larger percentage increase in profitability. More importantly, as part f a company’s overall value proposition, price plays a vital role in creating customer value and building customer relationships.
Major pricing strategies
The price the company charges will fall somewhere between one that is too high to produce any demand and one that is too low to produce a profit. Figure 1 summarizes the major considerations in setting price. A customer perception of the product’s value sets the ceiling for prices. If customers perceive that products price is greater than its value, they will not buy the product. Product costs set the floor for prices. If the company prices the product below its costs, the company’s profit will suffer. In setting the price between these two extremes, the company
must consider several internal and external factors, including the competitor’s strategies and prices, the overall marketing strategy and mix, and the nature of the market and demand.
Figure 1 Suggest three major pricing strategies: customer value-based pricings, cost-based pricing, and competition-based pricing.
- Customer Value based pricing – Setting price based on buyers’ perceptions of value rather than on the seller’s cost. The company sets its target price based on customer perceptions of the product value. These drive decisions about product design and what costs can be incurred. Thus, pricing begins with analyzing consumer needs and value perceptions, and price is set to march the perceived value.
In the end, customer will decide whether a products price is right. Pricing decisions, like other marketing mix decisions, must start with customer value. When customer buy a product, they exchange of something of value (the price) to get something of value (the benefits of having or using the product). Effective, customer-oriented pricing involves understanding how much value customers place on benefits they receive from the product and setting a price that captures this value.
Value-based pricing means that the marketer cannot design a product and marketing program and then set the price. Price is considered along with all other marketing mix variables before the marketing program is set.
Figure 1 compares the cost-based pricing and the value-based pricing.
Cost based pricing – setting prices based on the cost for producing, distributing, and selling the product plus a fair rate of return for effort and risk.
Types of costs a) Fixed Costs (Overhead) – Costs that do not vary with production or sales level.
b) Variable costs – costs that vary directly with the level of production.
c) Total costs – the sum of the fixed costs and variable costs for any given level of production
Costs as a function of production experience
d) Cost plus pricing – add a standard mark up to the cost of the product.
e) Break even pricing – Set price to break even on the costs of making and marketing a product
Figure 1 show the formula for cost-based pricing.
- Competition based pricing – Pricing that focuses on what competitors are doing.
To set the price of a product using competitor-based pricing you must find the rival product that is exactly the same. So, if you want to use this strategy you must be sure to know which are the competing products
higher margin is kept for ancillary product. It is an interesting form of Product mix pricing. 4. Two-part pricing
- When we go to an amusement park, there is a basic entry fee and then the fees for each ride is separate and the refreshments are also separate. This is known as a two-part fee. The initial fee is for the maintenance of the amusement park and the second fee is for the maintenance and the profits of the amusement rides within the park. A similar structure is observed in telecom companies where they charge you a basic amount on monthly basis and then the extra charges are based on your total usage.
- By product pricing
- Setting the price for by-products to make the main products price more competitive.
- By product pricing can simple be explained with the example of Crude oil. Companies like British Petroleum and Shell deal in a lot of Crude Oil and these companies also provide the finished goods like oil and petrol. So the pricing of the raw material as well as its by product is kept different. Generally, it is kept on the basis of cost of production of the by product. A similar pricing is observed in coconut oil production where the remaining coconut is rich in fiber and can be used as fertilizer. Sugarcane is used to make Sugar but after making sugar, the cane is sold off to building material manufacturers and sold off as Wood material.
- Product bundle pricing
- Combining several products and offering bundle at a reduced price.
- Generally, most product line prices deal with an individual product but a product bundling price deals with the combination of multiple products. On any given weekend, you will see the magic of Product bundling price whenever you see the promotional section of your newspaper.
- One retail store or another will be offering 1 packet of Oil free with 2 packets or 1 jean free on the purchase of 2 shirts, so on and so forth. This is a kind of product mix pricing which is used to push more products in the market at a lower price point. The margins are lesser but the cash movement is much faster, thereby giving liquidity to the brand. It is a favorite tactic of start-up brands.
Price Adjustment strategies
The pricing discount is one of the pricing strategies in which the markdown pricing of your merchandise is lowered. The target of the discount pricing strategy is to get maximum customer traffic and clear the old inventory from your business and also increase the sales. Most of the businesses practice changing the strategies so that they don’t have to depend only on pricing discounts for a long time. One should be careful while using a pricing discount strategy because if you continuously mark down the price of the product, then you could end up losing a lot of money. Also, if all the products are continually marked down, then the customers will not feel the value of the product.
You cannot always rely on pricing discounts, and larger companies have a lower price on bulk products. This is why it is difficult for smaller businesses to compete with them.
The price of the product is the word to motivate more customers to buy the product, but merely announcing the price drop may not be enough and could also lead to a reverse negative impact on the business. The pricing discount should be introduced at an appropriate time for selected buyers and those who respond quickly.
Discount - A straight reduction in price on purchases during stated period of time or of larger quantities. Allowance
- Promotional money paid by manufacturers to retailers in return for an agreement to feature the manufacturers products in some way.
The 7 Price Adjustment Strategies
Price Adjustment Strategy Description
Discount and allowance pricing Reducing prices to reward customer responses such as paying early or promoting the product
Segmented pricing Adjusting prices to allow for differences in customers, products or locations
Psychological pricing Adjusting prices for psychological effect Promotional pricing Temporarily reducing prices to increase short-run sales Geographical pricing Adjusting prices to account for the geographic location of customers
Dynamic pricing Adjusting prices continually to meet the characteristics and needs of individual customers and situations
International pricing Adjusting prices for international markets
- Discount and Allowance Pricing
The first one of the price adjustment strategies is applied in a large share of businesses. Especially in B2B, this price adjustment strategy is rather common. Most companies adjust their basic price to reward customers for certain responses, such as the early payment of bills, volume purchases and off-season buying.
Discount and allowance pricing can take many forms: Discounts can be granted as a cash discount, a price reduction to buyers who pay their bills promptly. Typical payment terms look like this: “2/10, net 30”, meaning that payment is due within 30 days, but the buyer can deduct 2 per cent if the bill is paid within 10 days. Also, a quantity discount can be given, which is a price reduction to buyers who buy large volumes. A seasonal account is a third form of discount, being a price reduction to buyers who buy merchandise or services out of season.
Allowances refer to another type of reduction from the list price. For instance, trade-in allowances are price reductions given for turning in an old item when buying a new one. Especially in the car industry, trade-in allowances are very common. Promotional allowances refer to payments or price reductions to reward dealers for participating in advertising and sales support programs.
However, promotional pricing can have adverse effects. If it is used too frequently and copied by competitors, price promotions can create customers who wait until brands go on sale before buying them. Or the brand’s value and credibility can be reduced in the eyes of customers. The danger is in using price promotions as a quick fix in difficult times instead of sweating through the difficult process of developing effective longer-term strategies for building the brand. For that reason, price adjustment strategies such as promotional pricing must be treated with care.
- Geographical Pricing – Price Adjustment Strategies The next one of the price adjustment strategies is geographical pricing. In geographical pricing, the company sets prices for customers located in different parts of the country or world. Should the company risk losing the business of more-distant customers by charging them higher prices to cover the additional shipping costs? Or should the same prices be charged regardless of location?
There are five geographical pricing strategies: FOB-origin pricing: goods are placed free on board a carrier, the customer thus pays the freight from the factory to the destination. Price differences are the consequence. Uniform-delivered pricing: the company charges the same price plus freight to all customers, regardless of their location. Thus, there are no geographical price differences. Zone pricing: the company sets up two or more zones. All customer within a zone pay the same total price, the more distant the zone, the higher the price. Base-point pricing: the seller designates some city as a base point and charges all customers the freight cost from that city to the customer. This can level the geographical price differences if a central base-point is selected. Freight-absorption pricing: the seller absorbs all or part of the freight charges to get the desired business. Price differences are thus eliminated.
Dynamic Pricing – Price Adjustment Strategies Dynamic pricing refers to adjusting prices continually to meet the characteristics and needs of individual customers and situations. If you look back in history, prices were normally set by negotiation between buyers and sellers. Thus, prices were adjusted to the specific customer or situation. Exactly at that point, dynamic pricing starts. Instead of using fixed prices, prices are adjusted on a day-by-day or even hour-by-hour basis, taking many variables into account, such as current demand, inventories and costs. In addition, consumers can negotiate prices at online auction sites such as eBay.
International Pricing – Price Adjustment Strategies
The last one of the major price adjustment strategies is international pricing. Companies that market their products internationally must decide what prices to charge in the different countries in which they operate. The price that a company should charge in a country can depend on many factors, involving economic conditions, competitive situations, laws and regulations, and the development of the wholesaling and retailing system. In addition, consumer perceptions and preferences may vary from country to country, calling for differences in prices. Also, the company might have different marketing objectives in different markets, which require changes in pricing strategy.
Without doubt, costs play an important role in setting international prices. Higher costs of selling in another country, which is the additional costs of operations, product modifications, shipping and insurance, import tariffs and taxes, and even exchange-rate fluctuations may create a need to charge different markets in the various markets.
After having investigated the 7 price adjustment strategies, it is clear that their application depends on the specific situation the company is in. However, all of the price adjustment strategies can also do harm and damage if executed in the wrong way. Therefore, careful preparation, analysis and execution is an absolute prerequisite. Only then, the price adjustment strategies will lead to a short- and long-term increase in sales and continuous success.
Types of pricing discount
- Quantity discount
- Economies of scale as the principal commonly used in the concept of quantity discount. If the buyer agrees to buy a higher number of products from the seller, then he may end up getting the quantity discount. The number of units produced will reduce the unit cost of the production or manufacturing, thereby offering a discount to the buyer. The marketing and distribution expenses are also reduced because of the quantity discount.
- This discount can be offered for a large quantity of purchase over time or in a single purchase or over the volume purchase, which is measured in rupees or units.
For example, your customer may agree to purchase a bottle of shampoo, which costs $ a unit for two years every month, and he would get a discount of $2 every unit.
Another customer may agree to buy 25 bottles of shampoo at one time and get a discount of $2 per unit.
The quantity orders at one time will encourage a more significant number of sales, but fewer number of requests over a given period.
The advantage to the seller is that he has to process fewer orders and ship and invoice fewer products, thereby reducing the distribution costs since most of the products go to a single customer. These discounts have these benefits, and the discount is dependent on the total volume of purchase for a given period, which could be anywhere between one month to 1 year. However, these discounts do not encourage repeat purchase from the buyer after the discount is over.
Functional Discounts
- Functional discounts are also termed as trade discounts. They are provided to the middleman to perform functions in the distribution of commodities of products. This is the reason why trade discounts are also called a functional discount. For example, a bookseller may get some discount from the publisher at the rate of say 20%, 22%, 25% on orders of 5 to 10, 10 to 30, 30 to 100 respectively these discounts are a presentation of a system of graded incentives.
- The discounts increase as the orders go up and are not fixed, unlike Quantity discounts.
- The trade discounts are given to distributors because they perform multiple functions within the distribution channel. This is why they should be compensated accordingly. For example, some wholesalers provide storage facilities to the manufacturer; they also help to set up displays for the retailer and extend them a credit period as well.
Promotional Discount
- Promotional discounts are given to the distributors because they promote the product of the manufacturer by unique displays, local advertising, or other promotional materials that are customized. These allowances use a percentage of reduction in the pricing, or they may be outright cash payment either to the distributor or to the promoter.
Seasonal Discount
- There is always up and down in every business. These periodic fluctuations affect regular activities in business activity. They may affect the market in a significant way and fluctuate to the entire market. To compensate for the losses that occurred during fluctuations, businesses come up with a seasonal discount.
- For example, special discounts are offered to people who shop at night instead of peak hour. Heaters in winter and air-conditioners in summer are offered at specials reduced prices in specific months to boost the sales.
- The more elastic the demand for the product, the better is the price discount it gets. For example, the morning shows for films, long-distance phone calls in the
boost profits by 33% if the sales volume is unaffected. A major factor in price increases is cost inflation.
Rising costs squeeze profit margins and lead companies to pass cost increases on to customers. Another factor leading to price increases is over demand: when a company cannot supply all that its customers need, it may raise its prices, ration products to customers, or both. An example for this tactic of initiating price changes is the worldwide oil and gas industry.
When raising prices, the firm must avoid being perceived as a price gouger. For instance, in the face of constantly rising petrol prices, angry customers often accuse the major oil companies of enriching themselves at the expense of consumers. And in fact, customers have long memories, meaning that they will eventually turn away from companies or even whole industries perceived as charging excessive prices. In the extreme, claims of price gouging may even lead to increased government regulation.
In order to avoid these problems in initiating price changes, some techniques can be applied. One is to simply maintain a sense of fairness surrounding any price increase. Price increases should be supported by company communications telling customers why prices are being raised. If there is no tangible reason for them, customers will not feel willing to pay more. Also, wherever possible, the company should consider ways to meet higher costs or demand without raising prices. For instance, more cost-effective ways to produce or distribute the products could be the key to avoiding price increases. The company could shrink the product or substitute less-expensive ingredients instead of raising the price. Or it can unbundle its market offering, by removing features, packaging or services, and separately pricing elements that were formerly part of the offer.
Of course, buyer reactions to price changes can be of quite diverse nature. They often depend on the way of initiating price changes. Customer reactions to price changes are not always straightforward: A price increase, which would normally lower sales, may have some positive meaning for buyers. For instance, what would you think if Rolex raised the price of a watch? It might be even more exclusive or better made. Similarly, a price cut in the case of Rolex would rather indicate reduced quality and a tarnished brand luxury image than that you get a better deal on an exclusive product. Most important to know is that a brand’s price and image are often very closely linked, which is why initiating price changes must be done carefully. Especially a drop in price can adversely affect how consumers view the brand.
Responding to Competitors Price Changes
How should a firm respond to a price cut that is initiated by a competitor? In markets characterized by high product homogeneity, the firm should search for ways to enhance its augmented product, but if it cannot find any, it will have to meet the price reduction. If the competitor raises its price in a homogeneous product market, the other firms might not match it, unless the price increase will benefit the industry as a whole. By not matching it, the leader will have to rescind the increase.
In nonhomogeneous product markets, a firm has more latitude to consider the following issues: 1. Why did the competitor change the price? Is it to steal the market, to utilize excess capacity, to meet changing cost conditions, or to lead an industrywide price change? 2. Does the competitor plan to make the price change temporary or permanent? 3. What will happen to the company's market share and profits if it does not respond? Are other companies going to respond? 4. What are the competitor's and other firms' responses likely to be to each possible reaction? Market leaders often face aggressive price cutting by smaller competitors trying to build market
share, the way Amazon has attacked Barnes and Noble. The brand leader can respond by:
- Maintaining price and profit margin, believing that (1) it would lose too much profit if it reduced its price, (2) it would not lose much market share, and (3) it could regain market share when necessary. However, the risk is that the attacker may get more confident, the leader's sales force may get demoralized, and the leader can lose more share than expected. Then the leader may panic, lower price to regain share, and find that regaining market share is more difficult and costly than expected.
- Maintaining price while adding value to its product, services, and communications. This may be less expensive than cutting price and operating at a lower margin.
- Reducing price to match the competitor's price, because (1) its costs fall with volume, (2) it would lose market share in a price-sensitive market, and (3) it would be hard to rebuild market share once it is lost, even though this will cut short-term profits.
- Increasing price and improving quality by introducing a new product to bracket the attacking brand.
- Launching a low-price fighter line or creating a separate lower-price brand to combat competition. Miller Beer, for example, launched a lower- priced beer brand called Red Dog. The best response varies with the situation. Successful firms consider the product's stage in the life cycle, its importance in the company's portfolio, the competitor's intentions and
resources, the market's price and quality sensitivity, the behavior of costs with volume, and the company's alternative opportunities.
Figure shows the assessing and responding to competitor price changes.
If the company decides that effective action can and should be taken, it might make any of the four responses: 1. Reduce price. The leader might drop its price to the competitor's price. It may decide that the market is price sensitive and that it would lose too much market share to the lower- priced competitor. Or it might worry that recapturing lost market share later would be too hard. Cutting price will reduce the company's profits in the short run. Some companies might also reduce their product quality, services and marketing communications to retain profit margins, but this ultimately will hurt long-run market share. The company should try to maintain its quality; is it cuts prices. 2. Raise perceived quality. The company might maintain its price but strengthen the perceived value of its offer. It could improve its communications, stressing the relative quality of its product over that of the lower-price competitor. The firm may find it cheaper to maintain price and spend money to improve its perceived quality than to out price and operate at a lower margin. 3. Improve quality and increase price. The company might increase quality and raise its price, moving its brand into a higher price position. The higher quality justifies the higher price, which in turn preserves the company's higher margins. Or the company can hold price on the current product and introduce a new brand at a higher price position. 4. Launch low-price fighting brand'. One of the best responses is to add lower-price items to the line or to create a separate lower-price brand. This is necessary if the particular
Predatory Pricing The practice of predatory pricing is when a firm sells its products or services at a price that is lower than its costs with the intention of pushing competitors out of the market. This practice is also prohibited federally, but it is very difficult to file formal charges. It is not illegal to sell at prices below costs to move inventory, but it is illegal to sell below costs with the intention of driving competitors out of the market. This is what makes it so difficult to prove when a firm engages in this practice, because one must determine the intent of the firm.
Pricing Across Channel Levels
Price Discrimination
Charging different price terms to customers at a specific level of trade is known as price discrimination. It is federally illegal unless a firm can prove that it is justified by a different level of costs associated with selling to various different retailers. The practice can also be acceptable if a firm is selling the same product at a different level of quality to different retailers. An example of price discrimination would be charging less for a child’s movie ticket than an adult. There is no cost difference associated with the price difference.
Retail Price Maintenance
Laws prohibiting the practice of retail price maintenance prevent firms from requiring dealers to charge a specific price for their products. The firm has every right to suggest a retail price, but no right to require it. For example, in the case of the iPhone K, Apple could not legally require resellers like Best Buy and Walmart to sell the phone at a specific price. This was made apparent when the iPhone 5C was released and Walmart decided to sell it for less than the price suggested by Apple.
Deceptive Pricing
The practice of deceptive pricing involves a seller stating a misleading discount or price that is not, in fact, available to consumers. The most common example of this practice is when firms advertise an extremely high “original” price to make a “sale” price seem more attractive, but it can also be as simple as advertising one price and charging another. Earlier this year, Walgreens was sued for this very practice after charging customers a higher price at the register than was advertised in their stores. This particular form of deceptive pricing is known as scanner fraud.
Chapter 2 Pricing understanding and Customer value
Course: Pricing Strategy (MM 302)
University: University of Southern Mindanao
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