Core Concepts of Marketing by John Burnett - HTML preview

CHAPTER 9

PRICING THE PRODUCT

decreased. For example, the cost of raw material to make

product will vary with

production.

A second shortcoming of break-even analysis is it assumes that variable costs are

stant. However, wages will increase with overtime and shipping discounts will

obtained.

Third, break-even assumes that all costs can be neatly categorized as fixed or variable. Where

advertising expenses are entered, break-even analysis will have a significant impact on the

resulting break-even price and volume.

Target Rates of Return

Break-even pricing is a reasonable approach when there is a limit on the quantity which a

finn can provide and particularly when a target return objective is sought. Assume, for ple, that the firm with the costs illustrated in the previous example detennines that it

provide no more than 10,000 units of the product in the next period of operation. Further-

more, the

has set a target for profit of 20% above total costs. Referring again to inter-

nal accounting records and the changing cost of production at near capacity levels, a new

total cost curve is calculated. From the cost curve profile, management sets the desirable

level of produclion at 80% of capacity or 8,000 units. From the total cost curve, it is

mined that the cost for producing 8,000 units is $18,000. Twenty percent of $18,000 is $3,600.

Adding this to the total cost at 8,000 units yields the point at that quantity through which

the total revenue curve must pass. Finally, $21 ,600 divided by 8,000 units yields the price

of $2.70 per un it; here the $3,600 in profit would be realized. The obvious shortcoming of

the target return approach to pricing is the absence of any infOlmation concerning the demand

for the product at the desired price. It is assumed that all of the units will be sold at the

price which provides the desired return.

It would be necessary, therefore, to determine whether

price

in fact

tive to potential customers in the marketplace. If break-even pricing is to

used, it should

be supplemented by additional information concerning customer perceptions of the rele-

vant range of prices for the product. The source of this information would most commonly

be survey research, as well as a thorou gh review of pricing practices by competitors in the

industry. In spite of their shortcomings, break-even pricing and

return pricing are very

common business practices.

Demand-Oriented Pricing

Demand-oriented pricing focuses on the nature of the demand curve fo r the product or

vice being priced. The nature of the demand curve is infl uenced largely by the structure of

the industry

which a finn competes . That is, if a firm operates in an industry that is

extremely competitive, price may be used to some strategic advantage in acquiring and

taining

share. On the other hand, if

firm operates in an environment with a few

dominant players , the range in which price

vary may be minimal.

Value-Based Pricing

If we consider the three approaches to setting price, cost-based is focused entirely

the

perspective of the company with very little concern for the customer; demand-based is focused

on the customer, but only as a predictor of sales ; and value-based focuses entirely on the

customer as a determinant of the total price/value package. M arketers who employ value-

based pricing

use the following definition:

is what you think your product is worth

to that customer at that time." Moreover, it acknowledges

marketing/price truths :

ALTERNATIVE APPROACHES TO DETERMININ G PRICE

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• To the customer, price is the only unpleasant part of buying .

• Price is the easiest marketing tool to copy.

• Price represents everything about the product.

Still, value-based pricing is not altruistic. It asks and

two questions : (1) what is

the highes t price I can charge and still make the sale? and (2) am I willing to sell at that

price? The fi rst question must take two primary factors into account: customers and com-

petitors. The second question is influenced by two more: costs and constraints. Let's dis-

cuss each briefl y.

Many customer-related factors are important in value-based pricing. For example,

it is critical to understand the customer buying process . How important is price? When is it considered? How is it used ? Another factor is the cost ofswitching. Have you ever watched the TV program "The Price is Right" ? If you have, you know that most consumers have

poor price know ledge. Moreover, their knowledge of comparable prices within a product

category--e.g., ketchup-is typically worse. So price knowledge is a relevant factor. Finally, the marketer must assess the cu stomers ' price expectations. How much do you expect to pay for a large pizza? Color TV? DVD? Newspaper? Swimming pool? These expectations

create a phenomenon called "sticker shock" as exhibited by gasoline, automobiles , and ATM fees.

A second factor influencing value-based pricing is competitors. As noted in earlier

chapters, defining competitio n is not always easy. Of course there are like-category com-

petitors such as Toyota and Nissan. We have already discussed the notion of pricing above,

below, and at the same level of these direct competitors. However, there are also indirect

competitors that consumers may use to base price comparisons . For instance, we may use

the price of a vacation as a basis for buying vacation clothes. The cost of eating out is com-

pared to the cost of groceries. There are also instances when a competitor, especially a mar-

ket leader, dictates the price for everyone else. Weyerhauser

the price for lumber.

Kellogg establishes the price for cereal.

If you're building a picnic table, it is fairly easy to add up your receipts and calcu-

late costs . For a global corporation, determining costs is a great deal more complex. For

example, calculating incremental costs and identifying avoidable costs are valuable tasks.

Incremental cost is the cost of producing each additional unit. If the incremental cost begins to

the incremental revenue, it is a clear sign to quit producing. Avoidable costs are

those that are unnecessary or can be passed onto some other institution in the marketing

channel. Adding costly features to a product that the customer cannot use is an example of

the former. As to the latter, the banking industry has been passing certain costs onto customers.

Another consideration is opportunity costs. Because the company spent money on

store remodeling, they are not able to take advantage of a discounted product purchase. Finally, costs vary from market-to-market as well as quantities sold. Research should

conducted

to assess these differences.

Although it would be nice to assume that a business has the freedom to set any price

it chooses, this is not always the case . There are a variety of constraints that prohibit such freedom. Some constraints are formal, such as government restrictions in respect to strategies like collusion and price-fixing. This occurs when two or more companies agree to charge

the same or very similar prices. Other constraints tend to be informal. 5xamples include

matching the price of competitors, a traditional price charged for a particular product, and

charging a price that covers expected costs .

Ultimately, value-based pricing offers the following three tactical recommendations:

• Employ a segmented approach toward price, based on such criteria as customer type,

location, and order size.

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