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Principles of Marketing

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Principles of Marketing ­ MGT301
Lesson ­ 25
Lesson overview and learning objectives:
In last Lesson we discussed the price its definition, focused on the problem of setting prices and
considered the factors marketers must consider when setting prices today we will look at general
pricing approaches, we will also examine pricing strategies for new-product pricing, product mix
A. Setting Pricing Policy
Pricing policy setting starts with setting the pricing objective that can be: Profit Oriented
(concerned with increase in profit), Sales Oriented (basically concerned with increase in sales) and
Status Quo Oriented. Whereas costs set the lower limit of prices, the market and demand set the
consumer and industrial
1 . S e le c tin g t h e p r ic in g o b je c tiv e
buyers balance the price
of a product or service
2 . D e te r m in in g d e m a n d
against the benefits of
owning it. Thus, before
3 . E s tim a tin g c o s ts
4 . A n a ly z in g c o m p e tito r s '
c o s ts , p r ic e s , a n d o ffe r s
5 . S e le c tin g a p r ic in g m e th o d
price and demand for its
product. In this section,
6 . S e le c tin g fin a l p r ic e
we  explain  how  the
relationship varies for different types of markets and how buyer perceptions of price affect the
pricing decision. Costs set the floor for the price that the company can charge for its product. The
company wants to charge a price that both covers all its costs for producing, distributing, and
selling the product and delivers a fair rate of return for its effort and risk. A company's costs may
be an important element in its pricing strategy. Companies with lower costs can set lower prices
that result in greater sales and profits. Company's pricing decisions are also affected by
competitors' costs and prices and possible competitor reactions to the company's own pricing
moves there fore while setting the prices theses facts should also kept in mind. Final step is setting
the final price by using different methods.
B. General Pricing Approaches
The price the company charges will be somewhere between one that is too low to produce a profit
and one that is too high to produce any demand. Figure summarizes the major considerations in
setting price. Product costs set a floor to the price; consumer perceptions of the product's value set
the ceiling. The company must consider competitors' prices and other external and internal factors
to find the best price between these two extremes. Companies set prices by selecting a general
Principles of Marketing ­ MGT301
pricing approach that includes one or more of three sets of factors. We examine these approaches:
the cost-based approach (cost-plus pricing, break-even analysis, and target profit pricing); the buyer-
based approach (value-based pricing); and the competition-based approach (going-rate and sealed-bid
a) Cost-Based Pricing
Cost-Plus Pricing
The simplest pricing method is cost-plus pricing--adding a standard markup to the cost of the
product. Construction companies, for example, submit job bids by estimating the total project cost
and adding a standard markup for profit. Lawyers, accountants, and other professionals typically
price by adding a standard markup to their costs. Some sellers tell their customers they will charge
cost plus a specified markup; for example, aerospace companies price this way to the government.
To illustrate markup pricing, suppose any manufacturer had the following costs and expected sales:
Then the manufacturer's cost per toaster is given by:
Unit Cost = variable Cost + Fixed Cost
Price - Variable Cost
The manufacturer's markup price is given by:
Markup Price
Unit Cost
(1-desired return on sale)
Do using standard markups to set prices make sense? Generally, no. Any pricing method that
ignores demand and competitor prices is not likely to lead to the best price. Markup pricing works
only if that price actually brings in the expected level of sales. Still, markup pricing remains popular
for many reasons. First, sellers are more certain about costs than about demand. By tying the price
to cost, sellers simplify pricing--they do not have to make frequent adjustments as demand
changes. Second, when all firms in the industry use this pricing method, prices tend to be similar
and price competition is thus minimized. Third, many people feel that cost-plus pricing is fairer to
both buyers and sellers. Sellers earn a fair return on their investment but do not take advantage of
buyers when buyers' demand becomes great.
Break-even Analysis and Target Profit Pricing
Another cost-oriented pricing approach is break-even pricing(or a variation called target profit
pricing he firm tries to determine the price at which it will break even or make the target profit it is
seeking. This pricing method is also used by public utilities, which are constrained to make a fair
return on their investment.
Target pricing uses the concept
of a break-even chart, which
T o ta l re v e n u e
shows the total cost and total
T a rg e t p ro fit
revenue expected at different
T o ta l c o s t
sales volume levels. Figure
B r e a k -e v e n p o in t
shows a break-even point.
Fixed costs are same regardless
of sales volume. Variable costs
are added to fixed costs to
F ix e d c o s t
form total costs, which rise
with volume. The total revenue
curve starts at zero and rises
S a le s v o l u m e in u n it s ( t h o u s a n d s )
with each unit sold.
Principles of Marketing ­ MGT301
Fixed Cost
Break-even Volume =
Price - Variable Cost
The manufacturer should consider different prices and estimate break-even volumes, probable
demand, and profits for each.
b) Value-Based Pricing
An increasing number of companies are basing their prices on the product's perceived value.
Value-based pricing uses buyers' perceptions of value, not the seller's cost, as the key to pricing.
Value-based pricing means that the marketer cannot design a product and marketing program and
then set the price. Price is considered along with the other marketing mix variables before the
marketing program is set.
Figure compares cost-based pricing with value-based pricing. Cost-based pricing is product driven.
The company designs what it considers to be a good product, totals the costs of making the
product, and sets a price that covers costs plus a target profit. Marketing must then convince
buyers that the product's value at that price justifies its purchase. If the price turns out to be too
high, the company must settle for lower markups or lower sales, both resulting in disappointing
Cost-based versus value-based pricing
Value-based pricing reverses this process. The company sets its target price based on customer
perceptions of the product value. The targeted value and price then drive decisions about product
design and what costs can be incurred. As a result, pricing begins with analyzing consumer needs
and value perceptions, and price is set to match consumers' perceived value.
A company using value-based pricing must find out what value buyers assign to different
competitive offers. However, measuring perceived value could be difficult. Sometimes, consumers
are asked how much they would pay for a basic product and for each benefit added to the offer.
Or a company might conduct experiments to test the perceived value of different product offers.
If the seller charges more than the buyers' perceived value, the company's sales will suffer. Many
companies overprice their products, and their products sell poorly. Other companies under price.
Under priced products sell very well, but they produce less revenue than they would have if price
were raised to the perceived-value level.
During the past decade, marketers have noted a fundamental shift in consumer attitudes toward
price and quality. Many companies have changed their pricing approaches to bring them into line
with changing economic conditions and consumer price perceptions. The best way to hold your
customers is to constantly figure out how to give them more for less."
Thus, more and more, marketers have adopted value pricing strategies--offering just the right
combination of quality and good service at a fair price. In many cases, this has involved the
introduction of less expensive versions of established, brand-name products. In many business-to-
business marketing situations, the pricing challenge is to find ways to maintain the company's
Principles of Marketing ­ MGT301
pricing power--its power to maintain or even raise prices without losing market share. To retain
pricing power--to escape price competition and to justify higher prices and margins--a firm must
retain or build the value of its marketing offer. This is especially true for suppliers of commodity
products, which are characterized by little differentiation and intense price competition. In such
cases, many companies adopt value-added strategies. Rather than cutting prices to match
competitors, they attach value-added services to differentiate their offers and thus support higher
c) Competition-Based Pricing
Consumers will base their judgments of a product's value on the prices that competitors charge for
similar products. One form of competition-based pricing is going-rate pricing, in which a firm bases
its price largely on competitors' prices, with less attention paid to its own costs or to demand. The
firm might charge the same, more, or less than its major competitors. In oligopolistic industries
that sell a commodity such as steel, paper, or fertilizer, firms normally charge the same price. The
smaller firms follow the leader: They change their prices when the market leader's prices change,
rather than when their own demand or costs change. Some firms may charge a bit more or less,
but they hold the amount of difference constant. Thus, minor gasoline retailers usually charge a
few cents less than the major oil companies, without letting the difference increase or decrease.
Going-rate pricing is quite popular. When demand elasticity is hard to measure, firms feel that the
going price represents the collective wisdom of the industry concerning the price that will yield a
fair return. They also feel that holding to the going price will prevent harmful price wars.
Competition-based pricing is also used when firms bid for jobs. Using sealed-bid pricing, a firm bases
its price on how it thinks competitors will price rather than on its own costs or on the demand.
The firm wants to win a contract, and winning the contract requires pricing less than other firms.
Yet the firm cannot set its price below a certain level. It cannot price below cost without harming
its position. In contrast, the higher the company sets its price above its costs, the lower its chance
of getting the contract.
Pricing decisions are subject to an incredibly complex array of environmental and competitive
forces. A company sets not a single price, but rather a pricing structure that covers different items in
its line. This pricing structure changes over time as products move through their life cycles. The
company adjusts product prices to reflect changes in costs and demand and to account for
variations in buyers and situations. As the competitive environment changes, the company
considers when to initiate price changes and when to respond to them.
C. New-Product Pricing Strategies
Pricing strategies usually change as the product passes through its life cycle. The introductory stage
is especially challenging. Companies bringing out a new product face the challenge of setting prices
for the first time. They can choose between two broad strategies: market-skimming pricing and market-
penetration pricing.
a) Market-Skimming Pricing
Many companies that invent new products initially set high prices to "skim" revenues layer by layer
from the market. Intel is a prime user of this strategy, called market-skimming pricing. Market
skimming makes sense only under certain conditions. First, the product's quality and image must
support its higher price, and enough buyers must want the product at that price. Second, the costs
of producing a smaller volume cannot be so high that they cancel the advantage of charging more.
Finally, competitors should not be able to enter the market easily and undercut the high price.
Market-Penetration Pricing
Rather than setting a high initial price to skim off small but profitable market segments, some
companies use market-penetration pricing. They set a low initial price in order to penetrate the
market quickly and deeply--to attract a large number of buyers quickly and win a large market
share. The high sales volume results in falling costs, allowing the company to cut its price even
Principles of Marketing ­ MGT301
further. Several conditions must be met for this low-price strategy to work. First, the market must
be highly price sensitive so that a low price produces more market growth. Second, production and
distribution costs must fall as sales volume increases. Finally, the low price must help keep out the
competition, and the penetration pricer must maintain its low-price position--otherwise, the price
advantage may be only temporary.
D. Product Mix Pricing Strategies
The strategy for setting a product's price often has to be changed when the product is part of a
product mix. In this case, the firm looks for a set of prices that maximizes the profits on the total
product mix. Pricing is difficult because the various products have related demand and costs and
face different degrees of competition. We now take a closer look at the five product mix pricing
a) Product Line Pricing
Companies usually develop product lines rather than single products. In product line pricing,
management must decide on the price steps to set between the various products in a line.
The price steps should take into account cost differences between the products in the line,
customer evaluations of their different features, and competitors' prices. In many industries, sellers
use well-established price points for the products in their line. The seller's task is to establish
perceived quality differences that support the price differences.
b) Optional-Product Pricing
Many companies use optional-product pricing--offering to sell optional or accessory products
along with their main product. For example, a car buyer may choose to order power windows,
cruise control, and a CD changer. Pricing these options is a sticky problem. Automobile companies
have to decide which items to include in the base price and which to offer as options. Until recent
years, The economy model was stripped of so many comforts and conveniences that most buyers
rejected it.
c) Captive-Product Pricing
Companies that make products that must be used along with a main product are using captive-
product pricing. Examples of captive products are razor blades, camera film, video games, and
computer software. Producers of the main products (razors, cameras, video game consoles, and
computers) often price them low and set high markups on the supplies. Thus, camera
manufactures price its cameras low because they make its money on the film it sells. In the case of
services, this strategy is called two-part pricing. The price of the service is broken into a fixed fee plus a
variable usage rate. Thus, a telephone company charges a monthly rate--the fixed fee--plus charges
for calls beyond some minimum number--the variable usage rate. Amusement parks charge
admission plus fees for food, midway attractions, and rides over a minimum. The service firm must
decide how much to charge for the basic service and how much for the variable usage. The fixed
amount should be low enough to induce usage of the service; profit can be made on the variable
d) By-Product Pricing
In producing processed meats, petroleum products, chemicals, and other products, there are often
by-products. If the by-products have no value and if getting rid of them is costly, this will affect
the pricing of the main product. Using by-product pricing, the manufacturer will seek a market for
these by-products and should accept any price that covers more than the cost of storing and
delivering them. This practice allows the seller to reduce the main product's price to make it more
competitive. By-products can even turn out to be profitable. For example, many lumber mills have
begun to sell bark chips and sawdust profitably as decorative mulch for home and commercial
Sometimes, companies don't realize how valuable their by-products are.
Principles of Marketing ­ MGT301
Product Bundle Pricing
Using product bundle pricing, sellers often combine several of their products and offer the bundle
at a reduced price. Thus, theaters and sports teams sell season tickets at less than the cost of single
tickets; hotels sell specially priced packages that include room, meals, and entertainment; computer
makers include attractive software packages with their personal computers. Price bundling can
promote the sales of products consumers might not otherwise buy, but the combined price must
be low enough to get them to buy the bundle.
Table of Contents:
  1. PRINCIPLES OF MARKETING:Introduction of Marketing, How is Marketing Done?
  5. MARKETING CHALLENGES IN THE 21st CENTURY:Connections with Customers
  6. STRATEGIC PLANNING AND MARKETING PROCESS:Setting Company Objectives and Goals
  7. PORTFOLIO ANALYSIS:MARKETING PROCESS,Marketing Strategy Planning Process
  8. MARKETING PROCESS:Analyzing marketing opportunities, Contents of Marketing Plan
  9. MARKETING ENVIRONMENT:The Companyís Microenvironment, Customers
  10. MARKETING MACRO ENVIRONMENT:Demographic Environment, Cultural Environment
  12. THE MARKETING RESEARCH PROCESS:Developing the Research Plan, Research Approaches
  14. CONSUMER BUYING BEHAVIOR:Model of consumer behavior, Cultural Factors
  15. CONSUMER BUYING BEHAVIOR (CONTINUED):Personal Factors, Psychological Factors
  16. BUSINESS MARKETS AND BUYING BEHAVIOR:Market structure and demand
  17. MARKET SEGMENTATION:Steps in Target Marketing, Mass Marketing
  18. MARKET SEGMENTATION (CONTINUED):Market Targeting, How Many Differences to Promote
  19. Product:Marketing Mix, Levels of Product and Services, Consumer Products
  20. PRODUCT:Individual product decisions, Product Attributes, Branding
  21. PRODUCT:NEW PRODUCT DEVELOPMENT PROCESS, Idea generation, Test Marketing
  23. KEY TERMS:New-product development, Idea generation, Product development
  24. Price the 2nd P of Marketing Mix:Marketing Objectives, Costs, The Market and Demand
  25. PRICE THE 2ND P OF MARKETING MIX:General Pricing Approaches, Fixed Cost
  26. PRICE THE 2ND P OF MARKETING MIX:Discount and Allowance Pricing, Segmented Pricing
  27. PRICE THE 2ND P OF MARKETING MIX:Price Changes, Initiating Price Increases
  28. PLACE- THE 3RD P OF MARKETING MIX:Marketing Channel, Channel Behavior
  29. LOGISTIC MANAGEMENT:Push Versus Pull Strategy, Goals of the Logistics System
  30. RETAILING AND WHOLESALING:Customer Service, Product Line, Discount Stores
  31. KEY TERMS:Distribution channel, Franchise organization, Distribution center
  32. PROMOTION THE 4TH P OF MARKETING MIX:Integrated Marketing Communications
  33. ADVERTISING:The Five Mís of Advertising, Advertising decisions
  34. ADVERTISING:SALES PROMOTION, Evaluating Advertising, Sales Promotion
  35. PERSONAL SELLING:The Role of the Sales Force, Builds Relationships
  36. SALES FORCE MANAGEMENT:Managing the Sales Force, Compensating Salespeople
  38. DIRECT MARKETING:PUBLIC RELATIONS, Major Public Relations Decisions
  39. KEY TERMS:Public relations, Advertising, Catalog Marketing
  40. CREATING COMPETITIVE ADVANTAGE:Competitor Analysis, Competitive Strategies
  41. GLOBAL MARKETING:International Trade System, Economic Environment
  42. E-MARKETING:Internet Marketing, Electronic Commerce, Basic-Forms
  43. MARKETING AND SOCIETY:Social Criticisms of Marketing, Marketing Ethics