Chapter 12 – Pricing Concepts and Strategies: Establishing Value
Price – The overall sacrifice a consumer is willing to make to acquire a specific product or service. This
includes the money paid in exchange for the item but also other sacrifices can be non monetary, such as
the value of time and energy spent acquiring item or the shipping and travel costs.
Consumers judge the benefits a product delivers against the sacrifices necessary to obtain it
Key is to match product or service price with the consumers value perceptions.
A price set to low may signal poor quality or performance, or other negative attributes.
Consumers don’t necessarily want a low price all the time for all products, they want high value
for their money which may come at a high or low cost
However consumers usually rank price as one of the most important components of their
Price is not just a sacrifice, but an information cue for consumers as well, price says a lot about
the product or services quality.
The 5 C’s of Pricing
1) Company Objectives
5) Channel Members
1) Company Objectives –Different firms have different goals. Each firm embraces an objective that
seems to fit where management thinks the firm needs to go to be successful. Usually reflects how the
firm intends to grow; increase sales, decrease competition, build customer loyalty etc.
Profit Orientation – Even though all company objectives may ultimately be profit motivated,
firms implement profit orientation by focussing on...
o a) Target Profit Pricing – A pricing strategy implemented by firms when they have a
particular profit goal as their overriding concern; uses price to stimulate certain level of
sales at a certain profit per unit.
o b) Maximizing Profit Strategy – 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 profits are maximized
o c) 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 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. New firm might focus on unit sales and market share at
first and be willing to accept less profit per unit to start. o Firms may set prices low to discourage new firms from entering the market, encourage
current firms to leave the market, take market share from competitors – all to gain
overall market share
o Companies can gain market share simply by offering a high-quality product at a fair
Competitor Orientation – A company objective based on the premise that the firm should
measure itself primarily against its competition. Value is only implicitly considered when
pursuing competitor orientation
o Competitive Parity – set prices that are similar to those of major competitors
Customer Orientation – Explicitly invokes the concept of value and sets prices to match
consumer expectations. Could be a low price if that’s what the firms target market values or
could be a high quality luxury product with a high price point.
2) Customers – The most important C because it pertains to understanding consumers reactions to
different prices. To determine how firms account for customers when they develop pricing strategies
must look at foundation of traditional economics.
Demand Curves and Pricing – Demand curve shows how many units of a product or service
consumers will demand during a specific period of time at different prices. Most curves are
downward sloping, with price on vertical access and quantity demanded on horizontal axis. As
price goes down the quantity purchased increases.
o Knowing the demand curve for a product or service enables firms to examine different
prices in terms of the resulting demand and relative to its overall objective
o Prestige products or services - Consumers purchase for their status rather than
functionality. The higher the price, the greater status associated, and greater exclusivity.
Demand curve looks like a reverse C. As price goes up, so do sales, until a point where
only certain people can afford it and then sales go down.
Price Elasticity of Demand – Measures how changes in price affect the quantity of the product
demanded; specifically, the ratio of the percentage change in the quantity demanded to the
percentage change in price.
o Generally consumers are less sensitive to price increases for necessary items like milk,
bread etc. because they have to purchase them even if price climbs
o When the price of milk goes up, the demand does not fall significantly. However when
the price of steaks rise to a point, people will begin to buy other products because there
may be cheaper substitutes.
o Elastic – Refers to a market for a product that is price sensitive; that is relatively small
changes in price will generate large changes in the quantity demanded.
o Inelastic – refers to a market for a product that is price insensitive, that is, relatively
small changes in price will not generate large changes in quantity demanded. Factors Influencing Price Elasticity of Demand – What causes these differences in price elasticity
o Income Effect – Refers to the change in the quantity of a product demanded by
consumers due to a change in their income. Generally as people income increases they
tend to shift their demand for low-priced products, to higher priced alternatives such as
steak instead of ground beef.
o Substitution Effect- Refers to the ability to substitute other products for the focal brand,
thus increasing the elasticity of demand for the focal brand. The greater the availability
of substitute products, the higher the price elasticity of demand is for a given product.
Getting consumers to believe that a particular brand is unique in some way
makes other brands seem less substitutable
o Cross Price Elasticity – The percentage change in demand for product A that occurs in
response to a percentage change in the price of product B. For example when the price
of DVD players dropped, the demand for DVD’s increased
Complementary Products – Products whose demand curves are positively
related, such that they rise or fall together; % increase in demand for one
results in % increase in demand for other.
Substitute products – Products for which the demand curves are negatively
related; that is a % change increase in quantity demanded for A results in a %
change decrease in the quantity demanded for B. For example DVD increase,
3) Costs – To make effective pricing decisions, firms must understand first their costs structures so they
can determine the degree to which their products or services will be profitable. Consumers use just the
price they will pay and the benefits they will receive to judge value, they will not pay more for an
inferior product because the company cannot be as cost efficient as the competitors.
Variable Cost – Those costs that vary with production volume. Usually labour, raw materials etc.
As a firm produces more or less of a good the variable costs increases or decreases with volume.
Generally expressed on a per unit basis
Fixed Cost – these costs remain essentially at the same level, regardless of any changes in the
volume of production. Typically include rent, utilities, insurance, salaries etc. Across reasonable
fluctuations in volume they remain the same
Total cost – The sum of the variable and fixed costs. TC = FC + X(VC/unit)
Break Even Analysis – 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 – the prices less the variable cost per unit.
o Helps assess pricing strategies because it clarifies the conditions in which different
prices make a product or service profitable 4) Competition – there are three levels of competition, each has its own set of pricing strategies
Oligopolistic – Occurs when there are only a few firms that dominate the market. Firms typically
change prices in reaction to competition and to avoid upsetting an otherwise unstable
competitive environment. Industries such as banking and retail gasoline
o Price wars – Occurs when two or more firms compete primarily by lowering their prices.
Often happen when a low cost provider enters a new market
Monopolistic – Occurs when there are many firms that sell closely related but not
homogeneous products; these products may be viewed as substitutes but are not perfect
o Many firms compete on the basis of product differentiation rather than pricing which
appeals more to consumers
Pure Competition – Occurs when different companies sell commodity products that consumers
perceive as substitutable; price usually is set according to laws of supply and demand
o Wheat, salt etc. When a commodity can be differentiated someone (like with a brand or
label) there is an opportunity for consumers to identify that product as unique form its
5) Channel Members – each of a products channel members (manufacturer, retailer etc.) can have
different perspectives on pricing strategies. For example a manufacturer could be looking to build a
brand as high quality or premium and want high prices while the retailer is focused on sales volume and
setting low prices to sell more units regardless of consumers’ perception of the brand
Grey Market – Employs irregular but not necessarily illegal methods. Generally it circumvents
authorized channels of distribution to sell goods at prices lower than those intended by the
Other Influences on Pricing
a) The Internet - The shift among consumers to acquiring more and more products, services, and
information online has made them more price sensitive and opened new categories of products to those
who could not access them before
Consumers ability to purchase goods online at highly discounted prices has pushed bricks and
mortise locations to focus consumer attention on the quality service, expertise and consulting
Search engines looking for lowest prices makes consumers more price sensitive because it
reduces the cost of finding a lower cost alternative
Online auction sites such as Ebay – brings items of all sorts to all kinds of buyers all over the
world. Help people determine the value of goods. b) Economic factors – specifically two trends, increase in consumers’ disposable income and status
consciousness. Some consumers appear willing to spend money for products that can convey their
status in some way.
Products once considered onl