CHAPTER 19

Pricing Concepts

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BUSINESS ETHICS DISCUSSION
Advanced Bio Medics (ABM) has invented a new stem-
cell–based drug that will arrest even advanced forms of
lung cancer. Development costs were actually quite low
because the drug was an accidental discovery by
scientists working on a different project. To stop the
disease requires a regimen of one pill per week for 20
weeks. There is no substitute offered by competitors.
ABM is thinking that it could maximize its profits by
charging $10,000 per pill. Of course, many people will die
because they can’t afford the medicine at this price.
 BUSINESS ETHICS DISCUSSION
People feel better when they think they are
getting a great bargain when they shop.
Knowing this, some retailers mark up items
above the traditional retail price and then offer
a 60 percent discount. If they had simply
discounted the normal retail price by 20
percent, the resulting “sale price” would have
been the same. One retailer says that he is just
making shoppers happy that they got a great
deal when he inflates the retail price before
discounting.
 
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 What is Price?
• The Sacrifice Effect of Price
– Price is that which is sacrificed to get a
good or service.
• The Information Effect of Price
– People infer quality information based on
price.
• Value Is Based upon Perceived
Satisfaction
– “Reasonable price” means “perceived
reasonable value.”

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4
 The Importance of Price

Price
Price allocates
allocates resources
resources
in
in aa free-market
free-market economy
economy

1
 Trends Influencing Price
Flood
Floodof
ofnew
newproducts
products

Increased
Increasedavailability
availabilityof
ofbargain-priced
bargain-priced
private
privateand
andgeneric
genericbrands
brands

Price
Pricecutting
cuttingas
asaastrategy
strategyto
tomaintain
maintainor
or
regain
regainmarket
marketshare
share

Internet
Internetused
usedfor
forcomparison
comparisonshopping
shopping

The
Thegreat
greatrecession
recession
1
6
Steps in Setting the Right Price

1.
1. Establish
Establish pricing
pricing objectives
objectives

2.
2. Estimate
Estimate demand,
demand, costs,
costs, and
and profits
profits

3.
3. Choose
Choose aa price
price strategy
strategy

4.
4. Fine-tune
Fine-tune with
with pricing
pricing tactics
tactics

Results lead to the right price

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 1. Establishing Pricing Objectives

Profit Oriented

Sales Oriented

Status Quo

2
8
Profit-Oriented Pricing Objectives

Profit-Oriented Pricing Objectives

Target
Target
Profit
Profit Satisfactory
Satisfactory Return
Returnonon
Maximization
Maximization Profits
Profits Investment
Investment

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 Profit Maximization
Profit
Profit
Maximization
Maximization

Setting prices so that total revenue is

as large as possible relative to total
costs.
Can be achieved through increasing
customer satisfaction or reducing cost.

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 Return on Investment
(ROI)
Net profit after taxes divided by
total assets.
ROI = Net profit after taxes
Total assets

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 Sales-Oriented Pricing
Objectives

Sales-Oriented Pricing Objectives

Market
Market Sales
Sales
Share
Share Maximization
Maximization

2
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 Sales Maximization
Rather than strive for market share,
sometimes companies try to
maximize sales.
Uses a short-term objective to
maximize sales
Ignores profits, competition, and the
marketing environment
May be used to sell off excess
inventory
2
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 Status Quo Pricing
Objectives

Status Quo Pricing Objectives

Maintain
Maintain Meet
Meet
existing
existing competition’s
competition’s
prices
prices prices
prices

2
2. Estimating Demand, Costs,
and Profits

Pricing Determinant

PLC
PLC
Demand Cost Competition
Competition
Demand Cost 4p
4pStrategy
Strategy
Others
Others

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 The Demand Curve

The
Thequantity
quantityofofaaproduct
productthat
that
Demand
Demand will
willbe
besold
soldininthe
themarket
marketatatvarious
various
prices
pricesfor
foraaspecified
specifiedperiod.
period.

The
Thequantity
quantityofofaaproduct
productthat
thatwill
will
Supply
Supply be
beoffered
offeredto
tothe
themarket
marketbybyaasupplier
supplier
at
atvarious
variousprices
pricesfor
foraaspecific
specificperiod.
period.

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The Supply Curve
Price Equilibrium
 How Supply and Demand
Establish Price

Price
Price The
Theprice
priceat
atwhich
whichdemand
demand
Equilibrium
Equilibrium and
andsupply
supplyare
areequal.
equal.

Consumers’
Consumers’responsiveness
responsiveness
Elasticity
Elasticity or
orsensitivity
sensitivityto
tochanges
changes
of
of Demand
Demand in
inprice.
price.

3
19
 Elasticity of Demand

Elastic Consumers buy more or less

Elastic of a product when the
Demand
Demand price changes.

Inelastic An increase or a decrease in

Inelastic price will not significantly
Demand
Demand affect demand.

An increase in sales exactly

Unitary
Unitary offsets a decrease in prices,
Elasticity
Elasticity so total revenue remains the
same.
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 Elasticity of Demand
If E > 1,
demand is
elastic.
If E < 1,
demand is
inelastic.
If E = 1,
demand is
unitary.

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21
 Factors that Affect
Elasticity of Demand
Availability
Availability of
of substitutes
substitutes

Price
Price relative
relative to
to
purchasing
purchasing power
power

Product
Product durability
durability

AA product’s
product’s other
other uses
uses

Rate
Rate of
of inflation
inflation
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 Yield Management Systems

Stimulate demand when demand is low;

Maximize profits when demand is high.

Discounting
Discountingearly
earlypurchases
purchases

Limiting
Limitingearly
earlysales
salesat
atdiscounted
discountedprices
prices

Overbooking
Overbooking capacity
capacity

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23
 Estimating Costs

Types
Types of
of Costs
Costs

Variable
Variable Fixed
Fixed Cost
Cost
Cost
Cost

Varies
Varies with
with changes
changes Does
Does not
not change
change
in
in level
level of
of output
output as
as level
level of
of output
output changes
changes

5
24
 The Cost Determinant
of Price

5
25
 Markup Pricing

The
Thecost
costof
ofbuying
buyingthe
theproduct
product
Markup
Markup from
fromthe
theproducer
producerplus
plusamounts
amounts
Pricing
Pricing for
forprofit
profitand
andfor
forexpenses
expensesnotnot
otherwise
otherwiseaccounted
accountedfor.
for.

The
Thepractice
practiceof
ofmarking
markingupup
Keystoning
Keystoning prices
pricesby
by100
100percent,
percent,or
or
doubling
doublingthe
thecost.
cost.

5
26
 Estimating Profits

Price X Sales Unit = Revenue

Revenue – Costs = Profit

Profit drives growth, salary increases,

and corporate investment

27
 Profit Maximization

AAmethod
methodof
ofsetting
settingprices
pricesthat
that
Profit
Profit occurs
occurswhen
whenmarginal
marginalrevenue
revenue
Maximization
Maximization equals
equalsmarginal
marginalcost.
cost.

Marginal The
Theextra
extrarevenue
revenueassociated
associated
Marginal with
Revenue withselling
sellingan
anextra
extraunit
unitof
ofoutput,
output,
Revenue or
orthe
thechange
changeinintotal
totalrevenue
revenuewith
with
(MR)
(MR) aaone-unit
one-unitchange
changeininoutput.
output.

5
28
Costs, Revenues, and Break-even Analysis

29
 Break-Even Pricing

5
30
 Other Determinants of Price
Stages
Stages of
of the
the
Product
Product Life
Life Cycle
Cycle

Competition
Competition

Distribution
Distribution Strategy
Strategy

Promotion
Promotion Strategy
Strategy

Perceived
Perceived Quality
Quality
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31
 Stages in the
Product Life Cycle
Introductory
Introductory stage:
stage: Price
Price is
is high
high

Growth
Growth stage:
stage: Price
Price stabilizes
stabilizes

Maturity
Maturity stage:
stage: Price
Price decreases
decreases

Decline
Decline stage:
stage: Price
Price decreases
decreases

6
32
 The Competition

 High prices may induce firms to

enter the market.

 Competition can lead to price

wars.

6
33
 Distribution Strategy

Manufacturers
Manufacturers Wholesalers/Retailers
Wholesalers/Retailers

• Offer a larger profit • Sell against the brand

margin or trade • Buy gray-market
allowance goods
• Use exclusive
distribution
• Franchising
• Avoid business with
price-cutting
discounters
• Develop brand loyalty

6
34
 The Impact of the Internet

AAprogram
programthat
thatsearches
searchesthe
theWeb
Web
Shopping
Shopping for
forthe
thebest
bestprice
pricefor
foraaparticular
particular
Bots
Bots item.
item.

Business-to-business
Business-to-businessauctions
auctions
Internet
Internet are
arelikely
likelyto
tobe
bethe
thedominant
dominantform
form
Auctions
Auctions of
ofonline
onlineauctions
auctionsininthe
thefuture.
future.

6
35
 The Relationship of
Price to Quality

When a purchase decision involves

uncertainty, consumers tend to rely on a high
price as a predictor of good quality.

Prestige
Prestige Pricing
Pricing
Charging a high price to help
promote a high-quality image.

6
36
3. Choose a Price Strategy

AAfirm
firmcharges
chargesaahigh
highintroductory
introductory
Price
Price price,
price,often
oftencoupled
coupledwith
withheavy
heavy
Skimming
Skimming promotion.
promotion.

AAfirm
firmcharges
chargesaarelatively
relativelylow
lowprice
price
Penetration
Penetration for
for aaproduct
productinitially
initiallyas
asaaway
waytoto
Pricing
Pricing reach
reachthe
the mass
massmarket.
market.

Status
StatusQuo
Quo Charging
Chargingaaprice
priceidentical
identicalto
toor
orvery
very
Pricing
Pricing close
closeto
tothe
thecompetition’s
competition’sprice.
price.

37
 Price Skimming

Strong Demand

Situations Unique/Superior Advantages

When
Price
Legal Protection of Product
Skimming
Is Successful
Technological Breakthrough

Blocked Entry to Competitors

38
 Penetration Pricing
Advantages Disadvantages
 Can lead to lower  Requires gear up for
cost per unit as
mass production
production expands
 Selling large
 Discourages or
volumes at low
blocks competition
prices
from market entry
 Strategy to gain
 Boosts sales and
market share may
provides large profit
fail
increases

39
 Status Quo Pricing

Advantages Disadvantages
 Simplicity  Strategy may
 ignore demand
Safest route to
and/or cost
long-term
survival for
small firms

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The Legality of Price Strategy

Unfair
Unfair Trade
Trade Practices
Practices

Price
Price Fixing
Fixing

Price
Price Discrimination
Discrimination

Predatory
Predatory Pricing
Pricing

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 Unfair Trade Practices and
Price Fixing
Laws
Lawsthat
thatprohibit
prohibitwholesalers
wholesalers
Unfair
UnfairTrade
Trade
Practices
and
andretailers
retailersfrom
fromselling
selling
PracticesActs
Acts
below
belowcost.
cost.
The
Thepractice
practiceof
ofcharging
chargingvery
verylow
low
Predatory
Predatory price
pricefor
foraaproduct
productwith
withthe
theintent
intent
Pricing
Pricing
of
ofdriving
drivingcompetitors
competitorsout
outof
ofaamarket
market

An
Anagreement
agreementbetween
betweentwotwo
Price
Price
Fixing
or
ormore
morefirms
firmson
onthe
theprice
pricethey
they
Fixing
will
willcharge
chargefor
foraaproduct.
product.

42
 Price Discrimination
The Robinson-Patman Act of 1936:

Seller
Seller Defenses
Defenses

Market
Market
Cost
Cost Competition
Competition
Conditions
Conditions

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4. Tactics for Fine-Tuning
the Base Price

Discounts
Discounts

Geographic
Geographicpricing
pricing

Other
Otherpricing
pricingtactics
tactics

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 Discounts, Allowances, Rebates,
and Value-Based Pricing

Promotional
Promotional
Quantity
Quantity Discounts
Discounts Allowances
Allowances

Cash
Cash Discounts
Discounts Rebates
Rebates

Zero
Zero Percent
Percent
Functional
Functional Discounts
Discounts
Financing
Financing

Seasonal
SeasonalDiscounts
Discounts Value-Based
Value-Based Pricing
Pricing

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 Geographic Pricing
The buyer absorbs the freight
FOB Origin
costs from the shipping point
Pricing
(“free on board”).
Uniform The seller pays the freight charges
Delivered and bills the purchaser an
Pricing identical, flat freight charge.
The U.S. is divided into zones, and
Zone Pricing a flat freight rate is charged to
customers in a given zone.
Freight The seller pays for all or part of
Absorption the freight charges and does not
Pricing pass them on to the buyer.
The seller charges freight from a basing point,
Basing-Point
regardless of the city from which the goods are
Pricing
shipped.
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 Other Pricing Tactics
Single-Price Tactic All goods offered at the same price
Flexible Pricing Different customers pay different prices
Trade-Ins Exchanging one item for a credit towards another.
Used often at car dealerships
Professional Used by professionals with experience,
Services Pricing training or certification
Price Lining Several line items at specific price points
Leader Pricing Sell product at near or below cost
Bait Pricing Lure customers through false or misleading price
advertising
Odd-Even Pricing Odd-number prices imply bargain
Even-number prices imply quality
Price Bundling Combining two or more products in a single package
Two-Part Pricing Two separate charges to consume a single good
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Pay What You Want Product price chosen by customers