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Chapter 9: Pricing-Understanding and Capturing Customer Value

What is a Price?
Narrowly, price is the amount of money charged for a product or service.
Broadly, price is the sum of all the values that consumers exchange for the
benefits of having or using the product or service.
Dynamic Pricing: charging different prices depending on individual customers
and situations.
Factors to consider when setting prices.
1. Customer perceptions of alue
!. "ther internal and e#ternal considerations
Marketing strategy, objectives, mix
Nature of the market and demand
Competitors strategies and prices
$. Product costs
1. Customer Vaue !erceptions
!n the end, customer will decide whether a product"s price is right. Pricing decisions li#e
all other mar#eting mix elements must start with $ustomer value. %hen customers buy a
product, they exchange something of value &the price' in order to get something in return
&the benefits of having the product'.
(alue Based Pricing:
)etting price based on buyer"s perceptions of value rather than on the sellers cost. *ood
pricing starts with a complete understanding of the value that a product or service creates
for its customers. (alue based pricing means that the mar#eter cannot design a product
and mar#eting program and then set the price.
+igure given below will compare value based pricing with cost based pricing.

%e now examine two types of value based pricing: Good value pricing and Value added
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3any companies have changed their pricing approaches to bring them into line with
changing economic conditions and consumer price perceptions. 3ore and more,
mar#eters have adopted good value pricing strategies4 offering 5ust the right
combination of 6uality and good service at a fair price.
.n important type of good value pricing at the retail level is 7every day low price8
&1D/P'. 1D/P involves charging a constant everyday low price with few or no
temporary price discounts.
!n contrast, high4low pricing involves charging higher price on an everyday basis but
running fre6uent promotions to lower prices temporarily on selected items.
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.ttaching value added features and services to differentiate a mar#eting offer and
support higher prices, rather than cutting prices to match competitors. !n many
companies, the challenge is to build the company"s pricing power4 !ts power to escape
price competition and to 5ustify higher prices and margins without losing mar#et share.
1g: $aterpillar $ompany offers its dealers a wide range of value added services
from guaranteed parts delivery to investment management advice and e6uipment training.
)uch added value supports a higher price.
". Company and !roduct costs
a. #ixed Costs$
$osts that do not vary with production or sales level.
b. Variabe Costs$
$osts that vary directly with the level of production.
Cost-%ased Pricing
:he simplest pricing method is cost plus pricing4 adding a standard mar#up to the
cost of the product.
.nother cost oriented pricing approach is brea# even pricing &:arget profit Pricing'. :he
firm tries to determine the price at which it will brea# even or ma#e the target profit it is
see#ing. :arget pricing uses the concept of brea# even chart which shows a total cost and
total revenue expected at different sales volume levels. +igure given below shows an
example of a brea# even chart.
%. &ther interna and externa considerations affecting price decisions
$ustomer perceptions of value set the upper limit for prices and costs set the
lower limit. ;owever in setting prices within these limits, the company must
consider a number of other internal and external factors. !nternal factors affecting
pricing include the company"s overall mar#eting strategy, ob5ectives, and
mar#eting mix as well as other organi<ation"s considerations. 1xternal factors
include the nature of the mar#et and demand, competitor"s strategies and prices
and other environmental factors.
"erall mar&eting strateg'( o)*ecties and mi#:
Price is the only one element of the company"s broader mar#eting strategy. :hus
before setting price, the company must decide on its overall mar#eting strategy
for the product or service. !f the company has selected its target mar#et and
positioning carefully, then its mar#eting strategy including price will be fairly
straight forward. +or example, positioning of :oyota"s /exus cars in the higher
income segment re6uired a higher price while the positioning of an ordinary
model of :oyota"s 1cho model cars re6uires low prices. :hus pricing strategy is
largely determined by decisions on mar#et positioning.
*eneral pricing ob5ectives might include survival, current profit maximi<ation,
mar#et share leadership or customer retention or relationship building. .t a more
specific level, a company can set prices to attract new customers or to profitably
retain existing ones.
Price is the only one of the mar#eting mix tools that a company uses to achieve its
mar#eting ob5ectives. Price decisions must be coordinated with product design,
distribution and promotion decisions to form a consistent and effective mar#eting
$ompanies often position their products on price and then tailor other mar#eting
mix decisions to the prices they want to charge. ;ere price is a crucial product
positioning factor that defines the product"s mar#et, competition and design.
3any firms support such price positioning strategies with a techni6ue called
7:.2*1: $-):!N*8, a potent strategic weapon. :arget costing reverses the
usual process of first designing a new product, determining its cost and then
as#ing 7$an we sell it for that price=8 !nstead it starts with an ideal selling price
based on customer value considerations, and then targets costs that will ensure
that the price is met.
"rgani+ational considerations:
3anagement must decide who within the organi<ation should set prices.
$ompanies handle pricing in a variety of ways. !n small companies, prices are
often set by top management rather than by the mar#eting or sales departments. !n
large companies, pricing is usually handled by divisional or product line
managers. !n industrial mar#ets, sales people may be allowed to negotiate with the
customers within certain price ranges. 1ven so top management sets the pricing
ob5ectives and policies, and it often approves the prices proposed by lower level
management or sales people.
,he mar&et and -emand
Pricing in different types of 3ar#et:
:he sellers pricing freedom varies with different types of mar#ets. 1conomists
recogni<e four types of mar#ets, each presenting a different price challenge. :hey
are as follows
1. Pure competition
!. .onopolistic competition
$. "ligopolistic competition
/. Pure monopol'
Under pure competition, the mar#et consists of many buyers and sellers trading
in a uniform commodity such as wheat, copper, or financial securities such as
stoc#s or bonds. No single buyer or seller has much effect on the going mar#et
place. . seller cannot charge more than the going price because buyers can obtain
as much as they need at the going price. !f price and profits rise, new sellers can
easily enter the mar#et. !n a purely competitive mar#et, mar#eting research,
product development, pricing, advertising and sales promotion play little or no
Under monopolistic competition( the mar#et consists of many buyers and sellers
who trade over a range of prices rather than a single mar#et price. . range of
prices occurs because sellers can differentiate their offers to buyers. .ny physical
product can be varied in 6uality, features, or style or the accompanying services
can be varied. Buyers see the differences in sellers products and will pay different
prices for them. Because there are many competitors in such mar#ets, each firm is
less affected by competitors pricing strategies than in oligopolistic mar#ets.
Under oligopolistic competition( the mar#et consists of a few sellers who are
highly sensitive to each other"s pricing and other mar#eting strategies. :he
product can be uniform &steel, aluminum etc' or non uniform &cars, computers
etc'. :here are few sellers because it is difficult for new sellers to enter the
mar#et. 1ach seller is alert to competitor"s strategies and moves. !f one of the
companies suddenly reduces the price of its products, buyers will 6uic#ly switch
to that supplier.
0n a pure monopol'( the mar#et consists of one seller. :he seller may be a
government monopoly or a private regulated monopoly. !n a regulated monopoly,
the government permits the company to set prices that yield a fair return. !n a non
regulated monopoly, companies are free to set up any price that mar#et will bear.
Price elasticit' of demand:
Price elasticity of demand is the measure of the sensitivity of demand to changes
in price. !f demand of the product is not changing with the changes of the price,
we say the demand is inelastic. !f the demand changes greatly with a small change
in price, we say demand is elastic.
1ew Product pricing strategies:
$ompanies bringing out a new product face the challenge of setting prices for the
first time. :hey can choose two broad strategies: mar#et s#imming pricing and
mar#et penetration pricing strategies.
.ar&et s&imming pricing:
)et a high price for a new product to 7s#im8 revenues layer by layer from
the mar#et.
$ompany ma#es fewer, but more profitable sales
%hen to 0se 3ar#et s#imming pricing:
Product"s 6uality and image must support its higher price.
$osts of low volume cannot be so high they cancel the advantage of
charging more.
$ompetitors should not be able to enter mar#et easily and undercut the
.ar&et Penetration:
)et a low initial price in order to 7penetrate8 the mar#et 6uic#ly and
$an attract a large number of buyers 6uic#ly and win a large mar#et share.
When to Use .ar&et Penetration:
3ar#et is highly price sensitive so a low price produces more growth.
$osts must fall as sales volume increases.
Need to #eep competition out or effects are only temporary.
Product .i# pricing strategies:
:he strategy for setting a product"s price often has to be changed when the product is
part of the product mix. !n this case, firm loo#s for a set of prices that maximi<es the
profits on the total product mix. %e now ta#e a closer loo# at the five product mix pricing
situations given below.
1. Product line pricing
!. "ptional-product pricing
$. Captie-product pricing
/. %'-product pricing
2. Product )undle pricing
!roduct'(ine !ricing
!nvolves setting price steps between various products in a product line based on:
Cost differences between products
Customer evaluations of different features
Competitors prices
!n a product line pricing, management must decide on the price steps to set between the
various products in a line.
&ptiona' and Captive'!roduct !ricing
Pricing optional or accessory products sold with the main product (e.g.,
ice maker with the refrigerator.
Pricing products that must be used with the main product (e.g.,
replacement cartridges for Gillette ra!ors.
)y'!roduct and !roduct )unde !ricing *trategies
By4Product Pricing
Pricing low"value by"products to get rid of them (e.g., animal manure
from !oo.
Product Bundle Pricing
Pricing bundles of products sold together (software, monitor, PC, and
Price 3d*ustment 4trategies
$ompanies usually ad5ust their basic prices to account for various customer differences
and changing situations. ;ere we examine the seven price ad5ustment strategies and the
names of these strategies are given below.
,. Discount and allowance pricing
9. )egmented pricing
>. Psychological pricing
?. Promotional pricing
@. *eographical pricing
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. discount is a straight reduction in price on purchases during a stated period of
time. 3ost companies give these discounts and allowances for certain response
from the customers such as early payment of bills, volume purchases and off4
season buying.
. 6uantity discount is a price reduction to buyers who buy large volumes. )uch
discounts provide an incentive to the customer to buy more from one given seller
rather than from many different sources.
. functional discount who perform certain functions& also called trade discount' is
offered by seller to trade channel members who perform certain functions such as
selling, storing, record #eeping.
. seasonal discount is a price reduction to buyers who buy merchandise or
services out of season. )easonal discounts allow the seller to #eep production
steady during an entire year.
3llowances are another type of reduction from the list price. :hey are the
promotional money paid by the manufacturers to retailers in return for an
agreement to feature the manufacturer"s products in some way.
,rades 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.
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)elling a product or service at two or more prices, where the difference in prices
is not based on differences in costs.
#. Customer"segment
$. Product"form
%. &ocation pricing
'. (ime pricing
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$onsiders the psychology of prices and not simply the economics.
$onsumers usually perceive higher4priced products as having higher 6uality.
$onsumers use price less when they can 5udge the 6uality of a product by
examining it or recalling experiences.
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%ith promotional pricing, companies will temporarily price their products below
list price and sometimes even below cost to create buying excitement and
)upermar#ets and department stores will price a few products as loss leaders to
attract customers to the shop in the hope that they will buy other items at normal
mar#ups. :he other forms of promotional pricing are given below.
/ow4!nterest +inancing
/onger %arranties
+ree 3aintenance
$ash 2ebates
)pecial41vent Pricing
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. company must also decide how to price its products for customers located at
different parts of the country or world. %e will loo# at five geographical pricing
#. )*+"origin pricing
:his practice means that the goods are placed free on board a carrier. .t that point the
title and responsibility pass to the customer, who pays the freight from the factory to the
$. ,niform"delivered pricing
0niform delivered pricing is the opposite of +-B pricing. ;ere the company charges the
same price plus freight to all customers, regardless of their location. :he freight charge is
set at the average freight cost.
%. -one pricing
Aone pricing falls between +-B origin pricing and uniform delivered pricing. :he
company sets two or more <ones. .ll customers within a given <one pay a single total
price, the more distant the <one, the higher the price.
'. +asing"point pricing
0sing the basing point pricing, the seller selects a given city as 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.
.. )reight"absorption pricing
+inally, the seller who is anxious to do business with a certain customer or geographical
area might use freight absorption pricing. 0sing this strategy, the seller absorbs all or part
of the actual freight charges in order to get the desired business. :he seller might reason
that if it can get more business, its average cost will fall and more than compensate for its
extra freight cost.