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Chapter 11

BU352 Chapter Notes - Chapter 11: Oligopoly, Cash Register, Price Floor

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Chapter 11: Pricing Concepts and Strategies: Establishing Value
The Importance of Pricing
-Price: Overall sacrifice a consumer is willing to make to acquire a specific g/s (monetary and
Benefits vs. Sacrifice necessary to obtain it, then make purchase decision
-Key to successful pricing: Match g/s with consumer’s value perceptions
-Price set too low may signal low quality, poor performance, or other negative attributes about
g/s  want high value instead, which may come with high or low price depending on bundle of
benefits the g/s delivers
-Price is only marketing mix that generates revenue = must be perfect or no sales
-Price is most challenging 4 P’s to manage – should view pricing decisions as strategic
opportunity to create value rather than afterthought to rest of marketing mix
The Five Cs of Pricing
Company Objectives
-Each firm embraces objective that fits where management thinks firm needs to go to be
successful – how firm intends to grow
Profit Orientation
-Profit Orientation: Implemented by focusing on target profit pricing, maximizing profits, or
target return pricing
-Target Profit Pricing: 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
-Maximizing Profits Strategy: 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
-Target Return Pricing: Pricing strategy implemented by firms less concerned with the absolute
level of profits and more interested in the rate at which their profits are generate relative to
their investments; designed to produce specific return on investment, usually expressed as % of
-E.g. Institute companywide policy that all products must provide for at least an 18% profit
margin to reach particular profit goal for firm
Sales Orientation
-Sales Orientation: Company objective based on belief that increasing sales will help firm more
than will increasing profits
-Some firms want more market share b/c they think it better reflects their success relative to
market conditions than sales alone
May set low prices to discourage new firms from entering market, encourage current
firms to leave market, and take market share away from competitors
Market share objective doesn’t always imply setting low prices
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Gain market share by offering high quality prouct at fair price
Competitor Orientation
-Competitor Orientation: Company objective based on premise that the firm should measure
itself primarily against its competition
-Competitive Parity: Firm’s strategy of setting prices that are similar to those of major
-Value only implicitly considered – competitors may be using value as part of pricing strategies
so copy strategy might provide value
Customer Orientation
-Customer Orientation: Pricing orientation that explicitly invokes the concept of customer
value and setting prices to match consumer expectations
-“No haggle” price structure to make purchase process simpler an easier for customers – lowers
overall price and increases value
-High priced, “state of the art” g/s in full anticipation of limited sales – enhances company’s
reputation an image, and increases company’s value in minds of consumers
-Set price with close eye to how consumers develop perceptions of value = most effective
pricing strategy, esp. if supported with consistent advertising and distribution strategies
-Understanding consumers’ reactions to different prices – want value and price is half of value
Demand Curves and Pricing
-Demand Curve: How many units of g/s consumers will demand during specific period at diff.
prices (common curve – as price increases, demand decreases)
-Knowing demand curve for g/s enables firm to examine diff. prices in terms of resulting
demand and relative to overall objective
-Prestige Products/Services: Those that consumers purchase for status vs. functionality
Higher the price, greater the status and exclusivity b/c fewer people can purchase it
Higher price = greater quantity sold up to certain point
When customers value increase in prestige more than price differential between
prestige product and other products, prestige product attains greater value overall
Price Elasticity of Demand
-Customers generally less sensitive to price increases for necessary items b/c they have to buy
even if price increases
-Price Elasticity of Demand: Measures how changes in a price affect the quantity of the product
demanded; specifically, the ratio of the % change in quantity demanded to % change in price
-Price Elasticity of Demand = % Change in Quantity Demanded/% Change in Price
-Elastic: G/s is price sensitive; Small changes in price generate large changes in quantity
demanded; When price elasticity < -1
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-Inelastic: G/s is price insensitive; Small price changes won’t generate large changes in quantity
demand; When price elasticity > -1
Factors Influencing Price Elasticity of Demand
-Income Effect: Refers to change in quantity of product demanded by consumers b/c of change
in their income
People’s income increases = shift demand from lower priced products to higher priced
When economy is goo and consumers’ incomes are rising overall, price elasticity of
steak may drop even though price remains constant
-Substitution Effect: Consumers’ ability to substitute other products for the focal brand, thus
increasing the price elasticity of demand for the focal brand
Greater availability of substitute products = higher price elasticity of demand for any
given product
Marketing plays critical role in making consumers brand loyal, making price elasticity of
demand for some brands low
-Cross-Price Elasticity: % change in demand for product A that occurs in response to % change
in price of product B
Complementary Products: Products whose demand curves are positively related; %
increase in demand for one results in % increase in demand for other
Substitute Products: Products for which changes in demand are negatively related; %
increase in quantity demanded for product A results in % decrease in quantity
demanded for product B
-Prices shouldn’t be based on costs b/c consumers make purchase decisions based on perceived
-Consumers use price they pay and benefits they receive to judge value
-Variable Costs: Vary with production volume (labour, materials)
More complex in service industry (e.g. hotel – variable costs each time room is rented
out but doesn’t incur costs if room isn’t booked)
Change depending on quantity produced – may increase/decrease with sig. changes in
-Fixed Costs: Those costs that remain essentially at the same level, regardless of any changes in
the volume of production (rent, utilities, insurance, admin. salaries, depreciation)
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