Chapter 3: Pricing and Price Management

Price

Consumers today have several product alternatives in the marketplace. Therefore, they have the opportunity to choose the best products satisfying their needs. Consumers compare prices with the relative value of the product. Because consumers focus on the value of the products, companies try to create value for consumers and obtain value from them in return. In this context, marketing management focuses on exchanging values between consumers and companies. Price plays a crucial role in this process. A well-determined price level provides enough profit as well as market share for companies and value for consumers. It also helps companies to compete with its counterparts successfully. Even if there are no other indicators, price remains a strong indicator of quality. Therefore, it communicates with consumers. On the other hand, environmental pressures such as faster technological progress, increased demand for services, proliferation of new products, economic uncertainty, increased global competition, and the changing legal environment affect price decisions.

Price is the amount of money paid by consumers to possess a product or get a service. Therefore, it can be considered as a formal ratio from economic perspective. For a consumer, price also includes physiological costs such as walking and waiting; and psychological costs such as hopes, perceived fairness, and self-image concerns etc. Hence, companies should consider all kinds of costs while making decisions. From consumers’ point of view, price can be used to indicate value when it is combined with products’ perceived benefits, and value

Price is one of the major factors affecting consumers’ purchase decisions. Price is more important for consumers in developing countries than consumers in developed countries. As the level of development of countries increases, the importance given to price decreases. Nonprice factors such as consumer tastes or preferences are more important in developed countries. Price can be set between two limits. The upper limit is customer value while the lower one is cost. The gap between these limits is called “Strategic Pricing Gap”.

The price should be determined between customer value9 and cost10. If the price of a product is set above reservation price, it will not be bought by consumers. This situation is called “endowment effect”. For example, if the company determines the price as 7 Turkish Liras, the products of the company will not be demanded by consumers. Therefore, the company should decrease the price below customer value (6 Turkish Liras). On the other hand, if the price of a product is determined below its costs, the company will not be able to make a profit either.

After determining two extremes of strategic pricing gap, a company should set its price by considering some factors. Firstly, the price level should create value for consumers.

Secondly, it should enable the company to compete with its counterparts. It should also prevent potential competitors to enter the market. Lastly, the price level should provide sufficient profit margins for intermediaries in distribution channels. Legal regulations as well as societal concerns should also be taken into account. Therefore, determining a price level between two extremes is not enough. If the price is determined higher than it should be, the company misses sales from potential customers. On the other hand, if the company sets price lower than it should be, it will miss profit.

Factors Affecting Price Decisions

Price can be affected by many factors. These factors can be grouped as external and internal factors13. The external factors include market and demand structure, economic factors, competitors’ costs and prices, distribution channels, legal regulations, and societal concerns. No single company can affect external factors; therefore, companies should adapt them. On the other hand, a company can manage internal factors such as costs, pricing aims of the firm, and diverse variables driven by other elements of marketing mix.

The external factors that a marketing manager needs to take into consideration when making a pricing decision are the market and demand structure of the firm, economic factors such as inflation or stagflation, the costs and prices of both direct and indirect competitors, the desires and requirements of its distribution channel, legal regulations in the country it operates, and the societal concerns.

Market and Demand Structure: Price decisions are affected by market structure. For instance, price signals are crucial in an oligopolistic market. If a company cuts price, the others will follow it. The price is determined by a seller in a monopoly because there are no competitors in the market. On the other hand, a single seller can’t affect the price in pure competition, because the market consists of many sellers and buyers of a uniform product. There are also lots of buyers and sellers in monopolistic competition, but there is an array of prices rather than just one. The reason is that the offers can be differentiated by sellers.

Economic Factors: Economic factors such as inflation or recession affect pricing decisions because they impact the activities of companies as well as consumers’ decisions. These kinds of factors affect purchasing power of consumers. Factors such as personal income, purchasing power, etc. should be considered while making decisions about pricing.

Competitors’ Costs and Prices: Competitors’ costs and prices could be a good starting point for setting a price. If the costs of a company are lower than its competitors’, the company will be advantageous in competition. Similarly, if the prices of a company are higher than its comppetitors’, the profit margin of the company will be higher.

Distribution Channels: The products are transported to consumers via distribution channels. Distribution channels consist of a variety of intermediaries such as wholesalers, retailers, etc. All these intermediaries try to make a profit or get a commission for their efforts. Therefore, the expectations of all members in the distribution channel should be considered while setting the price.

Legal Regulations: Legal regulations such as taxes, laws, and sanctions should be taken into account while determining the price. Marketers should consider different kinds of taxes such as value added tax, special consumption tax, etc. while making decisions about price. Therefore, taxes are also crucial from the viewpoint of consumers. Any decrease in tax rates will be reflected in prices. The decrease in prices will boost the demand. On the other hand, any increase in tax rates would lead to rise in price. The change in prices will affect demand. Therefore, the price level should be set correctly by considering tax rates.

Societal concerns: Companies should consider societal concerns while setting the price. Today’s highly conscious and well-educated consumers have begun to care about these kinds of concerns.

Costs: Cost is the lower limit of price (or price floor). There are different kinds of costs including fixed costs, variable costs, and total costs. Fixed costs refer to costs which are independent from the level of production. For example, rental fee should be paid monthly regardless of production or sales level. Variable costs are the ones that vary based on production level.

Pricing aims: Pricing aims include survival, financial, and marketing aims. Survival aims cover the short-term and try to carry on the activities of the company. Financial aims such as profit maximization or cash flow focus on the medium term. Marketing aims such as increasing market share or maintaining status quo cover the longterm.

Other Marketing Mix Elements: Product, place, and promotion should give messages to consumers in the same direction with price. For example, if the price of a product is high, the quality of the product should be high. Distribution channels and promotional activities should also be in accord with price.

Major Pricing Strategies

Price can be set between two extremes: cost and customer value. Price should be set neither lower than costs nor higher than customer value. Competitors’ prices should also be considered while setting a price level. Companies use three major pricing strategies including value-based pricing, cost-based pricing, and competition-based pricing.

Value-Based Pricing: In value-based pricing, customers’ value is used to charge a price for a product. Because the strategy is customer-driven, starting point is consumer. There are two types of value-based pricing: good-value pricing and value-added pricing. Good-value pricing combines higher quality with a lower price. For instance, a company may offer a less-expensive version of a product. A good example of this strategy is everyday low pricing (EDLP).

Cost-Based Pricing: Cost-based pricing includes different approaches such as cost-plus pricing or standard mark-up, break-even analysis, and target profit pricing. Cost-plus pricing approach determines the unit cost of the product firstly.

Break-even pricing is a cost-based pricing approach, too. The company determines the price to reach break-even point or target profit. Target profit pricing offers to sell products more than break-even volume with a price level which will lead to a target profit28. Cost-based pricing is a product-driven strategy. Therefore, starting point is the product. This approach is relatively simple but it focuses on intracompany data and ignores competitors.

Competitor-Based Pricing: Companies can use competitors’ prices to determine a price level. Competitor based pricing includes customary pricing, above-, at-, or below-market pricing, and loss-leader pricing. In customary pricing, price is dictated by the market. In above-, at-, or below-market pricing, competitors’ prices charged for similar products are used to set prices. It is not necessary to set exactly the same price with competitors. The price can be charged a little below or above. In lossleader pricing, many companies intentionally set a price level below customary price. The goals of the companies are to attract attention to a product.

Price Setting Process

The process of price setting consists of six steps. In the first step, pricing constraints and objectives are identified. Constraints include costs, competition, newness, and demand for product class and brand. Objectives consist of profit, market share, and survival. The second step consists of demand estimation, sales revenue estimation, and price elasticity estimation. The third step focuses on marginal analysis, cost estimation relation to profit, and break-even analysis. In the following step, an approximate price level is selected by using demand-oriented, costoriented and/or competition-oriented approaches. The fifth step focuses on setting a list or a quoted price. The company decides whether to follow a flexible price or one-price policy. In other words the company should decide whether to set the same or different prices for similar customers. The factors related to company, competition, and customers should be considered. The company should also consider incremental costs and revenue. In the last step, special adjustments are made because of rapid changing market conditions, customer preferences, etc.

Pricing Strategies

Marketers use different pricing strategies according to life cycle stages of products, changing conditions, and competition. For instance, new-product pricing strategies are followed in the introductory stage of the product life cycle. The whole marketing mix should be considered for profit maximization while setting prices. Price-adjustment strategies should be used to respond the changing environment. In this context, price changes are crucial.

New-Product Pricing Strategies: The pricing strategies change in different stages of product life cycle. Two pricing strategies can be used in the introductory stage: market-skimming and market-penetration. Marketskimming pricing sets high prices to skim higher revenue from the market. Prices are dropped to attract new buyers after a while. In other words, prices are decreased step by step to sell the products to new consumers. In marketpenetration pricing, companies set low prices to penetrate the market as much as possible.

Product Mix Pricing Strategies: Companies start to set prices by considering the whole marketing mix rather than just the product itself. In this way, profits can be maximized. There are six different product mix pricing strategies including product line pricing, by-product pricing, optional-product pricing, captive-product pricing, two-part pricing, and product bundle pricing.

In product line pricing, all the products in the line are considered. Price steps are determined for the products in the line. For example, a store may set three price levels for its shirts: 100, 150, or 200 Turkish Liras.

By-product pricing involves products produced unintentionally as an output of the manufacturing process of the main product. These kind of products have no (or little) value such as sawdust or fabric rag.

Optional-product pricing refers to accessory products sold with the main product. For example, consumers may buy steel rims or a parking sensor along with a car.

Captive-product pricing refers to complementary products which are used with the main product such as a printer cartridge. This strategy offers to determine low price for the basic product and high price for complementary product.

Two-part pricing includes a fixed fee and a variable usage fee. For example, a telecommunications company may charge a fixed monthly fee and variable usage fee.

In product bundle pricing, less demanded products are sold together with highly demanded ones at a discounted price. The aim of the strategy is to promote less demanded products. For instance, documentary channels can be sold together with sports channels.

Price-Adjustment Strategies: Markets are so dynamic, therefore, prices should be adapted to the fast changing environment. There are many price-adjustment strategies including dynamic pricing, psychological pricing, discount and allowance pricing, segmented pricing, geographical pricing, promotional pricing, and international pricing35. In dynamic pricing, prices are being adjusted continually to maximize revenue. For example, prices are changing thousands times a day in the airline sector. In psychological pricing, prices are adjusted based on a psychological viewpoint rather than an economic perspective. For instance, companies consider price thresholds in consumers’ mind while changing the prices of their products. Therefore, they can price a product at 9,99 rather than 10 Turkish Liras. Although the actual difference is 0,01, the psychological difference might be greater.

Discount and allowance pricing refers to a reduction in the price of the products for consumers who buy large quantities or pay early. In segmented pricing, prices are differentiated based on customer, location, or product rather than cost. Geographical pricing refers to setting different prices for consumers who are in different locations in order to cover high shipping costs. For instance, lower prices are charged for consumers who are close to oil refinery while higher prices are charged for ones who are far away. Promotional pricing reduces prices for a limited time period. The prices are set below the list price. International pricing refers to setting different prices for different countries. For example, a company may charge different prices for different countries, or it may set a fixed price for every country.