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Chapter 11

BU352 Chapter Notes - Chapter 11: Common Application, Ebay, Price Fixing


Department
Business
Course Code
BU352
Professor
Shirley Lichti
Chapter
11

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Chapter 11: Pricing Concepts and Strategies (Establishing
Value)
LO1: Explain what price is and its importance is establishing value in marketing
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 consumer’s 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
purchase decision
Price is not just a sacrifice, but an information cue for consumers as well, price says a lot
about the product or services quality.
LO2: Illustrate how the 5 C’s influence pricing decisions
The 5 C’s of Pricing
1. Company Objectives
2. Customers
3. Costs
4. Competition
5. Channel Members
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...
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.
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
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.

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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
Companies can gain market share simply by offering a high-quality product at a fair
price.
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
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.
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.
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
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.
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
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.
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.
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.
𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 = % 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆
Factors Influencing Price Elasticity of Demand What causes these differences in price
elasticity of demand?
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.
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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
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,
VCR decrease
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.
Contribution per unit the prices less the variable cost per unit.
Helps assess pricing strategies because it clarifies the conditions in which different
prices make a product or service profitable
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
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
substitutes.
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
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