Week 11 Learning Material

Key Concepts
 Reading: Principals of Marketing 17 edition: Chapter 11 Pricing Strategies:
Additional Considerations , Page 330

INTRODUCTION

HP, Epson, Canon, and Lexmark have long dominated the $50 billion printer industry with a
maddening “razor-and-blades” pricing strategy (as in give away the razor, then make your
profits on the blades). They sell printers at little or not profit. But once you own the printer,
you’re stuck buying their grossly overpriced, high-margin replacement ink cartridges.

Enter Kodak – with a unique solution. Kodak recently introduced its first line of printers –
EasyShare All-in-One printers – with a revolutionary pricing strategy that threatens to turn the
entire inkjet printer industry upside-down. Kodak sells its printers at premium prices with no
discounts, and then sells the ink cartridges for less. EasyShare printers sell for about $50 more
than comparable printers sold by competitors. EasyShare ink cartridges go for about half that
of prevailing competitors.

Using new technology, EasyShare ink cartridges use much less ink to make a print and the
cartridges contain no electronics (competitor’s cartridges use much more ink and contain some
electronics in the cartridge). This allows Kodak to charge less for its cartridges.

Kodak introduced the ThINK campaign to re-educate consumers about printer and ink pricing.

It’s too soon to tell whether Kodak’s new pricing strategy is working, but early results are
promising.

NEW-PRODUCT PRICING STRATEGIES

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

Many companies that invent new products set high initial prices to “skim” revenues layer-by-
layer from the market. This is called market-skimming pricing.

Market skimming makes sense only under certain conditions.

o The product’s quality and image must support its higher price, and enough buyers must
want the product at that price.
o The costs of producing a smaller volume cannot be so high that they cancel the
advantage of charging more.
o Competitors should not be able to enter the market easily and undercut the high price.

Market-Penetration Pricing

Rather than setting a high 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.

Several conditions must be met for this low-price strategy to work.

o The market must be highly price sensitive so that a low price produces more market
growth.
o Production and distribution costs must fall as sales volume increases.
o 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.

PRODUCT MIX PRICING STRATEGIES

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.
Optional-Product Pricing

Many companies use optional-product pricing—offering to sell optional or accessory

Pricing these options is a sticky problem. The company has to decide which items to include in
the base price and which to offer as options.

Captive-Product Pricing

Companies that make products that must be used along with a main product are using captive-
product pricing. Producers of the main products often price them low and set high markups
on the supplies.

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.

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 fees.

By-Product Pricing

Using by-product pricing, a manufacturer will seek a market for by-products and should
accept any price that covers more than the cost of storing and delivering them.

By-products can even turn out to be profitable.

Product Bundle Pricing

Using product bundle pricing, sellers often combine several of their products and offer the
bundle at a reduced price.

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.

PRICE-ADJUSTMENT STRATEGIES

Companies usually adjust their basic prices to account for various customer differences and
changing situations.
The six price adjustment strategies are summarized in Table 11.2.

Discount and Allowance Pricing

Most companies adjust their basic price to reward customers for certain responses, such as
early payment of bills, volume purchases, and off-season buying.

The many forms of discounts include a cash discount—a price reduction to buyers who pay
their bills promptly. A typical example is “2/10, net 30,” which means that although payment
is due within 30 days, the buyer can deduct 2 percent if the bill is paid within 10 days.

A quantity discount is a price reduction to buyers who buy large volumes. Such discounts
provide an incentive to the customer to buy more from one given seller, rather than from many
different sources.

A functional discount (trade discount) is offered by the seller to trade-channel members who
perform certain functions, such as selling, storing, and record keeping.

A seasonal discount is a price reduction to buyers who buy merchandise or services out of
season.

Allowances are another type of reduction from list price.

Trade-in allowances are price reductions given for turning in an old item when buying a new
one.

Promotional allowances are payments or price reductions to reward dealers for participating
in advertising and sales support programs.

Segmented Pricing

Companies will often adjust their basic prices to allow for differences in customers, products,
and locations.

In segmented pricing, the company sells a product or service at two or more prices, even
though the difference in prices is not based on differences in costs.

Under customer-segment pricing, different customers pay different prices for the same
product or service.

Under product form pricing, different versions of the product are priced differently but not
according to differences in their costs.

Under location pricing, a company charges different prices for different locations, even
though the cost of offering each location is the same.
Using time pricing, a firm varies its prices by the season, the month, the day, and even the
hour.

Segmented pricing goes by many names. Some in the airline industry call it revenue
management. Airlines, hotels, and restaurants call it yield management.

For segmented pricing to be an effective strategy, certain conditions must exist.

o The market must be segmentable, and the segments must show different degrees of
demand.
o The costs of segmenting and watching the market cannot exceed the extra revenue
obtained from the price difference.
o The segmented pricing must also be legal.

Psychological Pricing

Price says something about the product. For example, many consumers use price to judge
quality.

In using psychological pricing, sellers consider the psychology of prices and not simply the
economics.

Another aspect of psychological pricing is reference prices—prices that buyers carry in their
minds and refer to when looking at a given product.

o The reference price might be formed by noting current prices, remembering past prices,
or assessing the buying situation.
o Sellers can influence or use these consumers’ reference prices when setting price.

For most purchases, consumers don’t have all the skill or information they need to figure out
whether they are paying a good price. They may rely on certain cues that signal whether a
price is high or low.

Even small differences in price can signal product differences.

Promotional Pricing

With promotional pricing, companies will temporarily price their products below list price and
sometimes even below cost to create buying excitement and urgency.

Promotional pricing takes several forms.

 The seller may simply offer discounts from normal prices to increase sales and reduce
inventories.
 Supermarkets and department stores will price a few products as loss leaders to attract
 customers to the store in the hope that they will buy other items at normal markups.
 Sellers will also use special-event pricing in certain seasons to draw more customers.
 Manufacturers sometimes offer cash rebates to consumers who buy the product from
dealers within a specified time; the manufacturer sends the rebate directly to the
customer.
 Some manufacturers offer low-interest financing, longer warranties, or free
maintenance to reduce the consumer’s “price.”

Promotional pricing can have adverse effects.

 Used too frequently and copied by competitors, price promotions can create “deal-
prone” customers who wait until brands go on sale before buying them.
 Constantly reduced prices can erode a brand’s value in the eyes of customers.
 Marketers sometimes use price promotions as a quick fix instead of sweating through
the difficult process of developing effective longer-term strategies for building their
brands.
 The frequent use of promotional pricing can also lead to industry price wars. Such
price wars usually play into the hands of only one or a few competitors—those with the
most efficient operations.

Geographical Pricing

A company also must decide how to price its products for customers located in different parts
of the country or world.

1. FOB-origin pricing is a practice that means the goods are placed free on board (hence,
FOB) a carrier. At that point the title and responsibility pass to the customer, who pays
the freight from the factory to the destination.
2. Uniform-delivered pricing is the opposite of FOB pricing. Here, the company charges
the same price plus freight to all customers, regardless of their location. The freight
charge is set at the average freight cost.
3. Zone pricing falls between FOB-origin pricing and uniform-delivered pricing. The
company sets up two or more zones. All customers within a given zone pay a single
total price; the more distance the zone, the higher the price.
4. Using basing-point pricing, the seller selects a given city as a “basing point” and
charges all customers the freight cost from that city to the customer location, regardless
of the city from which the goods are actually shipped. Some companies set up multiple
basing points to create more flexibility: they quote freight charges from the basing-
point city nearest to the customer.
5. The seller who is anxious to do business with a certain customer or geographical area
might use freight-absorption pricing. Using this strategy, the seller absorbs all or part
of the actual freight charges in order to get the desired business.

Dynamic Pricing
Dynamic pricing offers many advantages for marketers. Internet sellers can mine their
databases to gauge a specific shopper’s desires, measure his or her means, and instantaneously
tailor products to fit that shopper’s behavior, and price products accordingly. Many B2B
marketers monitor inventories, costs, and demand at any given moment and adjust prices
instantly. Buyers also benefit from the Web and dynamic pricing.

International Pricing

Companies that market their products internationally must decide what prices to charge in the
different countries in which they operate.

In some cases, a company can set a uniform worldwide price. However, most companies
adjust their prices to reflect local market conditions and cost considerations.

The price that a company should charge in a specific country depends on many factors,
including economic conditions, competitive situations, laws and regulations, and development
of the wholesaling and retailing system.

Consumer perceptions and preferences also may vary from country to country, calling for
different prices. Or the company may have different marketing objectives in various world
markets that require changes in pricing strategy.

Costs play an important role in setting international prices. Travelers abroad are often
surprised to find that goods that are relatively inexpensive at home may carry outrageously
higher price tags in other countries.

In some cases, such price escalation may result from differences in selling strategies or market
conditions.

In most instances, however, it is simply a result of the higher costs of selling in another
country—the additional costs of product modifications, shipping and insurance, import tariffs
and taxes, exchange rate fluctuations, and physical distribution.

PRICE CHANGES

Companies often face situations in which they must initiate price changes or respond to price
changes by competitors.

Initiating Price Changes

Initiating Price Cuts

Several situations may lead a firm to consider cutting its price.

o One such circumstance is excess capacity. In this case, the firm needs more business
 and cannot get it through increased sales effort, product improvement, or other
measures.
o Another situation leading to price changes is falling market share in the face of strong
price competition.
o A company may also cut prices in a drive to dominate the market through lower costs.
Either the company starts with lower costs than its competitors, or it cuts prices in the
hope of gaining market share that will further cut costs through larger volume.

Initiating Price Increases

A successful price increase can greatly increase profits.

o A major factor in price increases is cost inflation. Rising costs squeeze profit margins
and lead companies to pass cost increases along to customers.
o Another factor leading to price increases is over demand. When a company cannot
supply all that its customers need, it can raise prices, ration products to customers, or
both.

Companies can increase their prices in a number of ways to keep up with rising costs.

Prices can be raised almost invisibly by dropping discounts and adding higher-priced units to
the line. Or prices can be pushed up openly.

In passing price increases on to customers, the company must avoid being perceived as a price
gouger.

Companies also need to think of who will bear the brunt of increased prices.

Price increases should be supported by company communications telling customers why prices
are being increased. Whenever possible, the company should consider ways to meet higher
costs or demand without raising prices.

Buyer Reactions to Price Changes

Customers do not always interpret price changes in a straightforward way.

A brand’s price and image are often closely linked. A price change, especially a drop in price,
can adversely affect how consumers view the brand.

Competitor Reactions to Price Changes

Competitors are most likely to react when the number of firms involved is small, when the
product is uniform, and when the buyers are well informed about products and prices.
The company must guess each competitor’s likely reaction. If all competitors behave alike,
this amounts to analyzing only a typical competitor. In contrast, if the competitors do not
behave alike, then separate analyses are necessary.

Responding to Price Changes

If a company decides that effective action can and should be taken, it might make any of four
responses.

1. It could reduce its price to match the competitor’s price. The company should try to
maintain its quality as it cuts prices.
2. The company might maintain its price but raise 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.
3. The company might improve quality and increase price, moving its brand into a
higher-price position. The higher quality justifies the higher price that in turn preserves
the company’s higher margins.
4. The company might launch a low-price “fighting brand”—adding a lower-price item
to the line or creating a separate lower-price brand. This is necessary if the particular
market segment being lost is price sensitive and will not respond to arguments of
higher quality.

PUBLIC POLICY AND PRICING

Price competition is a core element of our free-market economy. In setting prices, companies
are not usually free to charge whatever prices they wish.

Many federal, state, and even local laws govern the rules of fair play in pricing.

The most important pieces of legislation affecting pricing are the Sherman, Clayton, and
Robinson-Patman acts, initially adopted to curb the formation of monopolies and to regulate
business practices that might unfairly restrain trade.

Pricing Within Channel Levels

Federal legislation on price-fixing states that sellers must set prices without talking to
competitors. Otherwise, price collusion is suspected.

Sellers are also prohibited from using predatory pricing—selling below cost with the
intention of punishing a competitor or gaining higher long-run profits by putting competitors
out of business. This protects small sellers from larger ones who might sell items below cost
temporarily or in a specific locale to drive them out of business.
Pricing Across Channel Levels

The Robinson-Patman Act seeks to prevent unfair price discrimination by ensuring that sellers
offer the same price terms to customers at a given level of trade.

Price discrimination is allowed if the seller can prove that its costs are different when selling to
different retailers. Or the seller can discriminate in its pricing if the seller manufactures
different qualities of the same product for different retailers. The seller has to prove that these
differences are proportional.

Retail (or resale) price maintenance is prohibited—a manufacturer cannot require dealers to
charge a specified retail price for its product. Although the seller can propose a manufacturer’s
suggested retail price to dealers, it cannot refuse to sell to a dealer who takes independent
pricing action, nor can it punish the dealer by shipping late or denying advertising allowances.

Deceptive pricing occurs when a seller states prices or price savings that mislead consumers or
are not actually available to consumers. This might involve bogus reference or comparison
prices, as when a retailer sets artificially high “regular” prices then announces “sale” prices
close to its previous everyday prices.

Deceptive pricing issues include scanner fraud and price confusion. The widespread use of
scanner-based computer checkouts has led to increasing complaints of retailers overcharging
their customers.

Price confusion results when firms employ pricing methods that make it difficult for
consumers to understand just what price they are really paying.

Treating customers fairly and making certain that they fully understand prices and pricing
terms is an important part of building strong and lasting customer relationships.