buck,” The Globe and Mail, July 8, 2008, p. B2.
This pre-publication material is for review purposes only. Any typographical or technical errors will be corrected prior to publication. Copyright © 2013 Pearson Canada Inc. All rights reserved.
d er ve re s s ht rig Al l c. In a ad an C ar so n Pe 20 13 © rig ht op y C
Price Strategy and Determination
tuck_stx_ch10.indd 2
11/14/11 4:01 PM
er ve
d
HOW IMPORTANT ARE PRICING DECISIONS TO THE SUCCESS OF A BRAND (OR COMPANY)? WHAT FACTORS INFLUENCE THE PRICE DECISIONS AN ORGANIZATION MAKES FOR ITS PRODUCTS? WHAT METHODOLOGIES DOES A MANAGER CONSIDER WHEN ESTABLISHING A SELLING PRICE?
ht
s
re s
Consumer...
rig
reaction to rising food prices is taking its toll on supermarket chains like Loblaws, Sobeys, and Metro. Facing rising
expensive goods and are switching to cheaper alternatives. The rapid expansion of discounters like Walmart is
c.
The cost savings mean lower prices for consumers. There are many external influences an organization must consider when establishing its own prices. Shaving pennies here and there may not seem like much, but to
by expanding their food sections. Walmart’s superstores
C
now contain a complete supermarket. Walmart has condi-
ar so n
tioned shoppers over the years to look for bargains, and as
a result supermarkets like Loblaws and others are having trouble increasing prices even though their costs are rising.
Pe
If there’s a silver lining to this situation, it’s in the fact that both Loblaws and Sobeys operate their own discount chains.
20 13
Loblaws operates No Frills and Real Canadian Superstores, and Sobeys operates FreshCo. These stores carry fewer
important to their bottom line. This chapter introduces some of the basic pricing concepts used in marketing strategy. The discussion initially focuses on the variety of markets that Canadian firms operate in and the implications these markets have for pricing strategy. The external and internal factors influencing pricing strategy are then discussed. Finally, the issues of how pricing strategy is used to achieve marketing objectives and what specific methods are available for determining prices are addressed. Refer to the concept map for a visual impression of the chapter content.
C
op y
rig ht
©
products than mainstream supermarkets. Fewer products
supermarkets like Loblaws, Sobeys, and Metro, it is vitally
3
an
placing added pressure on the established supermarkets
focus on products that customers are more apt to purchase.
In
ing their buying behaviour—they have stopped buying more
means less shipping, labour, and logistics planning, and a
a
accustomed to rising food prices, they have begun chang-
ad
on the price hikes to their customers. While customers are
Al l
costs from their suppliers, they have been forced to pass
CHAPTER
tuck_stx_ch10.indd 3
10 11/14/11 4:01 PM
get the topic: HOW IMPORTANT ARE PRICING
DECISIONS TO THE SUCCESS OF A BRAND (OR COMPANY)?
d
The Definition and Role of Price
• A fare charged on a bus or train
re s
s
ht
rig
Al l
c.
In
a
ad
an
• A club membership
C
• Rent charged for an apartment
ar so n
• The rate of interest on a loan • A bid at an online auction site • Admission charged at a theatre
From a marketing organization’s perspective, price is the factor that contributes to revenues and profits. An organization must consider a multitude of variables in order to arrive at fair and competitive prices in the marketplace while providing reasonable revenues, profits, and return on investment internally.
A high price can create a favourable image and influence consumer perception of quality.
Price Defined “The exchange value of a good or service in the marketplace.”
C
op y
rig ht
©
20 13
Pe
Chapter 10
4
Price is defined as the exchange value of a good or service in the marketplace. The key word in this definition is “value.” The value of a good or service is derived from its tangible and intangible benefits and from the perception a consumer has of it once he or she has been subjected to other marketing influences. Let us use an example to explain what tangible and intangible benefits are. A young male decides to buy a top-of-the-line model of Adidas basketball shoes. They are endorsed by star basketball player Derek Rose (Chicago Bulls). The shoe will have a very high price because it is made of the best materials and the finest technology that Adidas is known for. Those are the tangibles the young buyer might look at. More than likely, however, the young male is more impressed with the style of the shoe and the aura that surrounds the endorsement by Derek Rose. The shoe will impress his friends—and that’s what he really wants. Those characteristics are the intangibles— intangibles that justify a higher price for the shoes. Prices take many forms and terms. Consider the following examples of price: • Your college tuition fees
Price is only one element of the marketing mix, but it can be the most important. For example, a prominent retailer such as Walmart relies on price to establish and maintain its image with consumers. Many experts believe that Walmart has set the price bar so low that it has actually caused competitors who couldn’t match their prices to go out of business. Walmart currently uses the slogan “Save Money. Live Better” to reinforce its positioning strategy. As another measure of the importance of price, consider that during the recession in 2008 and 2009 sales revenue at Walmart increased while most key competitors suffered declines in revenue. Consumers were switching to Walmart because it offered good value at reasonable price levels—effective positioning by Walmart! At the opposite end of the scale are specialty retailers such as Harry Rosen, an upscale men’s clothing emporium. Customers of Harry Rosen view price as an unimportant variable in the purchase decision. Customers may not buy as much at Harry Rosen when the economy takes a turn for the worse, but it is the image created by the high prices that attracts the upscale clientele when they do buy. Harry Rosen’s customers get some psychological satisfaction knowing they are wearing a quality suit! In a relatively free market economy such as Canada’s, price is also a mechanism for ensuring adequate levels of competition. In a free and open market, where competition is strong, supply and demand factors influence price. Thus, when demand for a good increases, marketing organizations have the flexibility to increase price. When demand for a product drops, organizations tend to lower prices to entice consumers to continue to buy the product. As mentioned elsewhere in the textbook, when gasoline prices shoot up the demand for trucks and big automobiles drops off. Automobile companies have to resort to an array of incentives and discount financing to entice people to buy. As well, increases in energy costs have an impact on the cost of many products consumers buy; marketers have little alternative but to pass such increases on to consumers—a factor that ultimately affects demand.
er ve
PRICE The exchange value of a good or service in the marketplace.
Factors Influencing Price Decisions • Nature of Market • Consumer Demand • Production Costs • Marketing Costs • Distributor Profit Expectations • Pricing Objectives
Low prices present a better “value” proposition to consumers.
Marketers analyze conflicting influences in order to arrive at fair prices for consumers while producing desired profit for distributors and the company.
tuck_stx_ch10.indd 4
11/14/11 4:01 PM
think marketing:
NATURE OF THE MARKET
A firm’s ability to establish price depends on the type of market it operates in. In the Canadian economy, there are several different types of markets: pure competition, monopolistic competition, oligopoly, and monopoly. See Figure 10.1 for an illustration of these markets.
Many sellers with differentiated product.
Price Decision Criteria
Price based on open market. How much should be produced?
Controls
None. Dictated by market dynamics.
Oligopoly
Monopoly
Few large sellers with some product differentiation.
Single seller with unique product.
Price based on ompetition and c brand loyalty. How much should be produced and invested in marketing?
Price based on competition. Quick reaction to price changes. How much should be invested in marketing?
Price based on fair and reasonable profit for supplier.
Some.
Some (e.g., uniform beer pricing in retail outlets in some provinces).
By government or other regulatory body (e.g., CRTC).
a
ad
an
C
ar so n
Pe 20 13
Innovative products with significant benefits can be priced high; a price skimming strategy.
rig ht
©
Marketing expenditures are an investment. Pricing strategies have to produce a return on that investment.
rig
Al l
Many sellers with same or similar product.
c.
Competition and Product
Factor
Price Strategy and Determination
Monopolistic Competition
5
Pure Competition
In
>>>
10.1 Market Structures and Their Price Implications
ht
s
re s
Several major influences are considered when establishing the price of a product: the nature of the market the product competes in, the nature of consumer demand for the product, production and marketing costs incurred by the firm, and the markups and profits expected by distributors. With the exception of production and marketing costs, all other influences are external to the firm.
figure
er ve
Influences on Price
d
WHAT FACTORS INFLUENCE THE PRICE DECISIONS AN ORGANIZATION MAKES FOR ITS PRODUCTS?
Methods to Establish Price • Cost based pricing • Demand based pricing • Price skimming • Price penetration • Competitive bidding
C
op y
Pricing Objectives • To maximize sales • To maximize profit • To be competitively priced in market
Products with only marginal benefits and products that enter a market late usually have lower prices; a price penetration strategy.
tuck_stx_ch10.indd 5
Pricing Strategies Must Stay within the Law • Misleading Price Claims • Bait and Switch • Double Ticketing / Bar Code Violations • Predatory Pricing • Price Fixing
Organizations that violate pricing laws face the wrath of consumers and the courts.
11/14/11 4:01 PM
In an oligopoly, a competitor’s actions are monitored closely. The competition is so intense that if one firm raises or drops its price, other firms will quickly do the same. For example, if Esso raises its prices, Petro-Canada and Shell are likely to follow quickly. In fact, in a matter of hours, usually overnight, the price at every gas station in a city will increase to exactly the same figure. This reaction is especially pronounced in markets where the products are essentially the same. To many consumers, this practice hints at collusion and price fixing, though independent investigations by Industry Canada (a federal government agency) have never proven this to be so. Sometimes, price wars erupt between competitors, and consumers temporarily enjoy bargain-basement prices. In a price war, the consumer is the only winner. Very often, the price war places financial hardship on the companies involved. In a monopoly, a single seller of a good or service for which there are no close substitutes serves the market. With so much control, a company can manipulate supply and demand for the good or service and influence prices to the detriment of the public. In Canada, monopolies are not common, but they do exist in the service-industry sector as regulated monopolies. For example, utilities and power corporations such as SaskPower and Hydro-Quebec are provincially regulated monopolies. Cable television companies such as Rogers and Cogeco that have protected market areas (e.g., the local communities that each serve) are also monopolies. In a regulated monopoly, the government allows the supplier to set prices to ensure a reasonable amount of profit is earned so that the company can maintain and expand its operations when needed. Price increases must go through an approval process before they are implemented. The CRTC, for example, approves all rates of cable television suppliers.
PURE COMPETITION A market in which many small firms market similar products. LAW OF SUPPLY AND DEMAND The law declaring that an abundant supply and low demand lead to a low price, while a high demand and limited supply lead to a high price.
er ve
d
MONOPOLISTIC COMPETITION A market in which there are many competitors, each offering a unique marketing mix based on price and other variables. OLIGOPOLISTIC MARKET A market situation in which a few large firms control the market.
re s
MONOPOLY A market in which there is a single seller of a particular good or service for which there are no close substitutes. PRICE ELASTICITY OF DEMAND Measures the effect a price change has on the volume purchased.
ht
s
ELASTIC DEMAND A situation in which a small change in price results in a large change in volume.
an
ad
a
In
c.
Al l
rig
ar so n
C
In a market environment of pure competition, there are many small firms marketing the same basic product; therefore, no single firm can dictate or offset the market. Commodities such as wheat, barley, and sugar fall into this category, as do financial securities such as mutual funds. The firm has no choice but to charge the going market price, because buyers can buy as much as they need at that price. The market in this situation controls the selling price. The basic law of supply and demand applies: an abundant supply and low demand lead to a low price, while a high demand and limited supply lead to a high price. Often, it is simply expectations about supply or demand that have an impact on price. For example, if the supply of gasoline were expected to dwindle below normal demand, there would be a rush to buy the resource and its price would be driven up, at least temporarily. In other cases, it is the actual supply and demand that influences prices. The demand for stocks on the stock market influences the rate at which they are traded. If a market is characterized by monopolistic competition, there are many competitors selling products that, although similar, are perceived to be different by consumers. Companies marketing packaged-goods items such as coffee, cereal, and household cleaners operate in this kind of market, as do consumer electronics companies. The consumer always has lots of choice. Marketing strategy is designed to distinguish one’s own brand from the others. Such variables as product quality, service, style, function, and packaging are used to convey a difference to the consumer. Advertising is employed to present a certain image for the brand. The effectiveness of the marketing mix strategy determines a brand’s fate and explains why leading bands such as Coca-Cola (beverage market), Dove (personal care market), and Sony (consumer electronics market) are perceived to be better than other brands. These brands can charge a higher price for their products. Competing brands would charge less than the brand leaders. If the consumer thinks there are differences among the brands, brand loyalty can be created. Traditionally, consumers who are loyal to a brand are less likely to be influenced by price: that is, they are willing to pay a little more for the brand of their choice than for other brands. In an oligopolistic market, there are a few large sellers of a particular good or service. Industries traditionally associated with oligopolies are the commercial airline industry, dominated by Air Canada and WestJet; the telecommunications industry, dominated by Bell, Rogers, and Telus; and the retail gasoline industry, dominated by Petro-Canada, Imperial Oil, and Shell. Collectively, these brands control significant portions of their respective markets.
C
op y
rig ht
©
20 13
Pe
Chapter 10
6
INELASTIC DEMAND A situation in which a change in price does not have a significant impact on the quantity purchased.
tuck_stx_ch10.indd 6
CONSUMER DEMAND FOR THE PRODUCT The number of consumers in a target market and the demand they have for a product has a bearing on price. Essentially, there are two common principles at work. First, consumers usually purchase greater quantities at lower prices. Second, the effects of a price change on volume demanded by consumers must be factored into the pricing strategy. To illustrate, if price is increased and demand drops significantly, the objective of the price increase (higher sales revenue or profit) will not be achieved. This principle is referred to as price elasticity of demand. There are two types of demand: elastic demand and inelastic demand. Elastic demand describes a situation in which a small change
in price results in a large change in volume (e.g., price increases by 5 percent and volume drops by 15 percent). If demand is elastic, the firm’s total revenues go up as price goes down, and revenues go down when price goes up. Inelastic demand is a situation in which a price change does not have a significant impact on the quantity purchased. In this case, total revenues go up when prices are increased and go down when prices are reduced. For example, the Toronto Maple Leafs
increase ticket prices every year. Every ticket for every game is always sold regardless of how well the team performs. In comparison, some American NHL teams have to discount their ticket prices to generate a sellout. These demand concepts are illustrated in Figure 10.2. Canada’s two most common markets are monopolistic competition and oligopoly. In these markets demand is based on the need in the marketplace and the availability of substitute products. If demand for a product category is high, all competing firms can maintain high prices and reap the financial benefits. However, once a major competitor changes prices—say, lowers the price significantly—demand in the market can change. Such would be the case if a prominent brand such
11/14/11 4:01 PM
a one-year planning cycle. Unforeseen increases (those that happen quickly and unexpectedly) are a different matter. In such cases, a firm may choose to absorb the cost increases and accept lower profit margins, at least for the short term, in the hope that the situation will correct itself. If it does not, there is little choice but to pass the increase to channel members in order to ensure long-
10.2 The Differences between Elastic If demand is inelastic, consumers are not price sensitive. A large increase in price has a limited effect on sales volume.
In the illustration, when price increased from $500 to $750, revenue declined from $400 000 (800 units 3 $500) to $150 000 (200 units 3 $750).
In the illustration, when price increased from $750 to $1500, revenue increased from $225 000 ($750 3 300 units) to $300 000 ($1500 3 200 units).
Price
1500
1500
rig
ht
s
Price
term profitability. To illustrate, consider a situation currently faced by Kellogg’s, maker of popular brands of cereal. Kellogg’s stated that it had to increase its prices for the second time in six months due to rising prices for ingredients and fuel. At the same time, it also announced it was reducing the size of the box for many of its brands (Frosted Flakes, Froot Loops, and Apple Jacks, among many others). Reducing the size of the box is an indirect way of raising prices. Consumers tend to balk less at quantity reductions than they do price increases. In fact, a survey in Walmart stores revealed that Kellogg’s box-reduction strategy went virtually unnoticed by consumers.1 Large Canadian grocery chains feel the impact of such price changes immediately. In 2011, all food manufacturers were increasing their prices largely due to rising fuel prices. Supermarkets such as Metro, Sobeys, and Loblaws had no option but to pass the increases on to consumers. In doing so, they discovered they couldn’t raise prices too much because consumers simply switched to cheaper alternatives. Check out the retail price of cereal the next time you shop—you too will look for cheaper alternatives!
er ve
If demand is elastic, consumers are price sensitive. When price increases, demand goes down significantly.
d
and Inelastic Demand
re s
>>>
figure
Al l
1000 750
In
c.
500
Quantity
C
Cost Items
20 13
Ingredients
©
rig ht
10.3 Cost Components of a
Packaged-Goods Product
Pe
ar so n
>>>
figure
1.79 0.68
Labour
1.48
Manufacturing
0.20
Warehousing
0.34
Total Plant Cost
Costs that have a direct effect on price include the costs of labour, raw materials, processed materials, capital requirements, transportation, marketing, and administration. A common practice among manufacturing firms is to establish a total product cost, taking into consideration these elements as well as a desirable and fair gross profit margin. The addition of the profit margin to the cost becomes the selling price to distributors. Such a practice is based on the assumption that the resulting retail price will be acceptable to consumers. See Figure 10.3 for an illustration. The pricing decisions of an organization become increasingly difficult as costs rise. If cost increases are gradual and the amounts are marginal, a firm can usually plan its strategy effectively; it can build prices around projected cost increases for a period of time, using, say,
Add:
Gross Profit Margin (40%)
op y
Freight Cost
C
$ 15.75
Shipping Case
Add:
Total Product Cost List Price Add:
Actual Cost
Packaging (inner/outer)
PRODUCTION AND MARKETING COSTS
tuck_stx_ch10.indd 7
Price Strategy and Determination
as Sony dropped its prices for televisions for an extended period. Since it is a leader in the television market, such a move could put pressure on Hitachi, JVC, Panasonic, Toshiba, and others to respond. Such an action could occur if an economy slows down and sales of all television brands begin to stagnate. Consumer behaviour also has an impact on pricing strategy. A consumer may compare the price and quality of one product with other similar products; to other consumers, such matters as image, status, and prestige may be so important that the actual price of the product is ignored (a product such as a Rolex watch would be in this category). In the first case, the consumer behaves rationally, so the price of the product is important. In the second case, the consumer acts less rationally and is influenced by other factors, so price is less important. Thus, products aimed at status-seekers are apt to be priced high to convey prestige, while products targeted to the price-conscious would logically be priced low.
7
an
Quantity
a
200 400 600
ad
200 400 600 800
Retail Profit Margin (25%) Retail Price (per case of 24)
Selling Price at Retail
20.24 1.36
21.60 8.64
30.24 7.56 37.80
1.57
This example assumes a desired profit margin of 40% for the manufacturer of the product and a 25% markup at retail. The manufactured item is a case good that contains 24 packages in a shipping case. After all costs and profit margins are considered for the manufacturer and distributor, the price at retail is $1.57.
11/14/11 4:01 PM
CONSIDERATION OF CHANNEL MEMBERS
COST REDUCTIONS Reductions of the costs involved in the production process.
tuck_stx_ch10.indd 8
d
er ve
re s
s
ht
rig
Al l
c.
a
In
Pricing Objectives Influence Price Decisions
ing ingredient costs. In all of these examples the consumer winds up paying more for less. These are just a few examples. Does the consumer notice these changes? Do they care? A recent situation for Hellmann’s mayonnaise demonstrates why marketers do what they do. Hellmann’s options were to increase the price or find a way to absorb increases in costs. “Instead of increasing the price, they decided to shrink the size of the jars from 950 mL to 850 mL and change the containers from glass to plastic, which drastically cut manufacturing costs. But because of the reduced package size, the price of the mayonnaise has effectively gone up for the consumer. The increase is simply hidden.” The reality of the situation dictates these kinds of practices. Consumers are generally fed up with continual price increases and their behaviour is such that they simply rebel by switching to less expensive brands in the same product category. Consumers may switch to private label brands such as President’s Choice or even buy generic (no
name) store brands to save money. Today’s consumers seek value in a variety of ways. You be the judge. Is this practice sound marketing strategy or deceptive strategy? Are there risks associated with such a practice?
3
Quantity (thousands)
= 125 000
figure
2
Al l
=
Pro
Break-Even Point
er ve
Selling Price
fit
150 Revenue and Costs ($ thousands)
Costs
re s
Total Variable Costs 5 $15.00 per unit
s
Revenue
5 $50 000
ht
Total Fixed Costs
rig
Assumption
5 $25.00
5 $25.00 1 $5.00
5 $30.00
5 Wholesaler’s Selling Price 1 40%
C
b) Wholesaler’s Cost and Selling Price 5 Manufacturer’s Selling Price 1 20% Markup
c) Retailer’s Cost and Selling Price
5 $30.00 1 $12.00
5 $42.00
tuck_stx_ch10.indd 13
11/14/11 4:01 PM
find out how sports owners have reacted, read the Think Marketing box Sports Luxury Suites: From Boom to Bust.
PRICE PENETRATION Establishing a low entry price to gain wide market acceptance quickly.
PRICE PENETRATION
its product launches well in advance of the item being available. Effective marketing communications creates pent-up demand for the product— another factor that justifies a higher price. Prescription drug manufacturers invest heavily in research and development to develop new products. They price their products very high during their patent protection phase since they know lower-priced generic drug competitors will be on the market once their patent expires. A possible hazard of skimming is that competitors who see a product enjoying high profit margins, mainly due to the lack of competition and a skimming pricing strategy, are likely to bring similar products to the market very quickly. Users of a skimming strategy recognize that it is easier to lower prices than it is to raise prices during the life cycle of a product. Companies known for innovation (as in the case of Apple described above) have a pricing advantage. The fact that consumers are willing to pay more for their products certainly has an impact on sales revenue and profitability. For others to compete they must enter the market at a much lower price, which affects their ability to recover development costs and pay for marketing expenses.2 Luxury boxes in sporting arenas and stadiums used to command a very high price, especially in new buildings, but circumstances in the sports market have changed and prices have dropped significantly. To
a
In
c.
Al l
rig
ht
s
re s
er ve
d
A price penetration strategy establishes a low entry price to gain wide market acceptance for the product quickly. In this situation, price is typically an important factor in the buying decision; for example, a market may be segmented into various price points (budget brands, competitively priced brands, and expensive brands). The market is also one in which demand is elastic, meaning that any change in price has a direct impact on the quantity purchased. The objective of price penetration is to create demand in a market quickly, to build market share, and to discourage competitors from entering if the product is new. Research In Motion (RIM) entered the tablet market late with a product called PlayBook. Realizing that Apple had 90 percent market share and that other brands were also on the market, RIM had no option but to enter with a much lower price. The PlayBook was priced at $499, or about $200 less than Apple’s iPad. In this situation it will take RIM much longer to recover its research and development costs and initial marketing costs, but in the entire scheme of things RIM recognized it must be a player in this market. Lack of participation could harm the overall image of the company among customers and affect sales of other company products. RIM, with its BlackBerry, remains the dominant player in the corporate smartphone market.3
FPO
>>>
20 13
©
rig ht
op y
C
tuck_stx_ch10.indd 14
