Chapter 11 Pricing Concepts and Strategies: Establishing Value
The Five Cs of Pricing
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: 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: 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: 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.
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
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
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.
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.
Monopoly: occurs when only one firm provides the product or service in a
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.
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 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
o Search engines find the best price, and more informed purchases.
Two interrelated trends that have merged to impact pricing decisions:
o Increase in consumers’ disposable income
o Status consciousness
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
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
o Usually set on the basis of estimates of average costs.
Competitor-based pricing method: an approach that attempts to reflect
how the firm wants consumers to interpret its products relative to the
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 pricing method: focuses on the overall value of the product
offering as perceived by consumers, who determine value