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Chapter 11

ADM2320 Chapter 11

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University of Ottawa
Marzena Cedzynski

Chapter 11 Pricing Concepts and Strategies: Establishing Value The Five Cs of Pricing Company Objectives Profit Orientation  Profit orientation: a company objective that can be implemented by focusing on target profit pricing, maximizing profit, or target return pricing. o Target profit pricing: a pricing strategy implemented by firms when they have a particular profit goal as their overriding concern; uses price to stimulate a certain level of sales at a certain profit per unit. o Maximizing profit: a mathematical model that captures all the factors required to explain and predict sales and profits, which should be able to identify the price at which its profits are maximized. o Target return pricing: a pricing strategy implemented by firms less concerned with the absolute level of profits and more interested in the rate at which their profits are generated relative to their investments; designed to produce a specific return on investment, usually expressed as a percentage of sales. Sales Orientation  Sales orientation: a company objective based on the belief that increasing sales will help the firm more than will increasing profits.  Some firms may be more concerned about their overall market share than about dollar sales.  Adopting a market share objective does not always imply low prices. Competitor Orientation  Competitor orientation: a company objective based on the premise that the firm should measure itself primarily against its competition. o Competitive parity: a firm’s strategy of setting prices that are similar to those of major competitors. Customer Orientation  Customer orientation: pricing orientation that explicitly invokes the concept of customer value and setting prices to match customer expectations.  Can focus on customer satisfaction, matching customer-pricing expectations, “no-haggle” price policy. Customers Demand Curves and Pricing  Demand curve: shows how many units of a product or service consumers will demand during a specific period at different prices.  Static demand curves assume everything remains the same.  Prestige products or services: those that consumers purchase for status rather than functionality. Price Elasticity of Demand  Price elasticity of demand: measures how changes in a price affect the quantity of the product demanded; specifically, the ratio of the percentage change in quantity demanded to the change in price. o Elastic: refers to a market for a product or service that is price sensitive; that is, relatively small changes in price will generate fairly large changes in the quantity demanded.  1% decrease in price produces more than a 1% increase in quantity sold. o Inelastic: refers to a market for product or service that is price insensitive; that is, relatively small changes in price will not generate large changes in the quantity demanded.  1% decrease in price results in less that a 1% increase in quantity sold. Factors Influencing Price Elasticity of Demand  Income effect: refers to the change in the quantity of the product demanded by customers because of a change in their income.  Substitution effect: refers to customers’ ability to substitute other products for the focal brand, thus increasing the price elasticity of demand for the focal brand.  Cross-price elasticity: the percentage change in demand for Product A that occurs in response to a percentage change in price of Product B. o Complementary products: products whose demand curves are positively related, such that they rise or fall together; a percentage increase in demand for one results in a percentage increase in demand for the other. o Substitute products: products for which changes in demand are negatively related – that is, a percentage increase in the quantity demanded for Product A results in a percentage decrease in the quantity demanded for product B. Costs  Firms must understand their cost structures so they can determine the degree to which their products or services will be profitable.  In general, prices should not be based on costs because consumers make purchase decisions based on the perceived value. o Variable costs: those costs, primarily labour and materials, which vary with production volume. o Fixed costs: those costs that remain essentially the same level, regardless of any changes in the volume of production. o Total cost: the sum of the variable and fixed costs. Break-Even Analysis and Decision Making  Break-even point: the point at which the number of units sold generates just enough revenue to equal the total costs; at this point, profits are zero. o Contribution per unit: equals the price less the variable cost per unit; variable used to determine the break even point in units. ( )  Limitations: o Firms will have a variety of prices, so the price it would use in the break-even analysis probably represents an average price that attempts to account for these variances. o Prices often get reduced as quantity increases, so firms must perform several break-even analyses at different quantities. o Break-even analysis cannot indicate for sure how many units will sell at a given price. Competition  Monopoly: occurs when only one firm provides the product or service in a particular industry.  Oligopolistic competition: occurs when only a few firms dominate a market. o Price war: occurs when two or more firms compete primarily by lowering their prices.  Monopolistic competition: occurs when many firms sell closely related but not homogeneous products; these products may be viewed as substitutes but are not perfect substitutes.  Pure competition: occurs when different companies sell commodity products that consumers perceive as substitutable; price usually is set according to the laws of supply and demand. Channel Members  Grey market: employs irregular but not necessarily illegal methods; generally, it legally circumvents authorized channels of distribution to sell goods at prices lower than those intended by the manufacturer. Other Influences on Pricing The Internet  The shift among consumers to acquiring more and more products, services, and information online has: o Made them more price sensitive o Opened new categories of products to those who could not access them previously o Search engines find the best price, and more informed purchases. Economic Factors  Two interrelated trends that have merged to impact pricing decisions: o Increase in consumers’ disposable income o Status consciousness  Countervailing trend: o Customers attempting to shop cheap o Cross-shopping: the pattern of buying both premium and low-priced merchandise or patronizing both expensive, status-oriented retailers and price-oriented retailers.  Local economic conditions  Increasing globalization Pricing Strategies Cost-Based Methods  Cost-based pricing method: determines the final price to charge by starting with the cost, without recognizing the role that consumers or competitors’ prices play in the marketplace.  Requires that all costs can be identified and calculated on a per-unit basis.  The process assumes that these costs will not vary much for different levels of production. o Usually set on the basis of estimates of average costs. Competitor-Based Methods  Competitor-based pricing method: an approach that attempts to reflect how the firm wants consumers to interpret its products relative to the competitors’ offerings.  Premium pricing: a competitor-based pricing method by which the firm deliberately prices a product above the prices set for competing products to capture those consumers who always shop for the best or for whom price does not matter. Value-Based Methods  Value-based pricing method: focuses on the overall value of the product offering as perceived by consumers, who determine value
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