The price the company charges will fall somewhere between one that is too high to produce any demand and one that is too low to produce a profit. Figure 9.1 summarises the major considerations in setting price. Customer perceptions of the product’s value set the ceiling for prices. If customers perceive that the price is greater than the product’s value, they will not buy the product. Product costs set the floor for prices. If the company prices the product below its costs, company profits will suffer. In setting its price between these two extremes, the company must consider a number of factors, including its overall marketing strategy and mix, the nature of the market and demand, competitors’ strategies and prices, and a number of other internal and external factors.
Customer perceptions of value
In the end, the customer will decide whether a product’s price is right. Pricing decisions, like other marketing mix decisions, must start with customer value. When customers buy a product, they exchange something of value (the price) in order to get something of value (the benefits of having or using the product). Effective, customer-oriented pricing involves understanding how much value consumers place on the benefits they receive from the prod- uct and setting a price that captures this value.
Value-based pricing
Good pricing begins with a complete understanding of the value that a product or service creates for customers. Value-based pricing uses buyers’ perceptions of value, not the seller’s cost, as the key to pricing. Value-based pricing means that the marketer cannot design a product and marketing programme and then set the price. Price is considered along with the other marketing mix variables before the marketing programme is set.
FIGURE 9.1 Factors affecting price decisions
Figure 9.2 compares value-based pricing with cost-based pricing. Cost-based pricing is product driven. The company designs what it considers to be a good product, adds up the costs of making the product, and sets a price that covers costs plus a target profit. Marketing must then convince buyers that the product’s value at that price justifies its purchase. If the price turns out to be too high, the company must settle for lower mark-ups or lower sales, both resulting in disappointing profits.
Value-based pricing reverses this process. The company sets its target price based on customer perceptions of the product value. The targeted value and price then drive deci- sions about product design and what costs can be incurred. As a result, pricing begins with analysing consumer needs and value perceptions, and price is set to match consumers’
perceived value.
It is important to remember that ‘good value’ is not always the same as ‘low price’. For example, the German luxury goods manufacturer Montblanc, part of the Swiss firm Com- pagnie Financière Richemont SA, sells exclusive pens for hundreds of euros – a less expensive pen might write just as well, but some consumers place great value on the intangibles they receive from a ‘fine writing instrument’. Similarly, a Steinway piano – any Steinway piano – costs a lot. But to those who own one, a Steinway is a great value:
A Steinway grand piano typically runs anywhere from €40,000 to €165,000. The most popular model sells for around €72,000. But ask anyone who owns one and they’ll tell you that, when it comes to Steinway, price is nothing, the Steinway experience is everything. Steinway makes very high quality pianos – handcrafting each Steinway requires up to one full year. But more important, owners get the Steinway mystique. The Steinway name evokes images of classi- cal concert stages and the celebrities and performers who’ve owned and played Steinway pianos across more than 155 years.
But Steinways aren’t just for world-class pianists and the wealthy. Ninety-nine per cent of all Steinway buyers are amateurs who perform only in their homes. To such customers, whatever a Steinway costs, it’s a small price to pay for the value of owning one. As one Stein- way owner puts it, ‘My friendship with the Steinway piano is one of the most important and beautiful things in my life’. Who can put a price on such feelings?5
A company using value-based pricing must find out what value buyers assign to different competitive offers. However, companies often find it hard to measure the value customers will attach to their products. For example, calculating the cost of ingredients in a meal at a good restaurant is relatively easy. But assigning a value to other satisfactions such as taste, environment, relaxation, conversation and status is very hard. And these values will vary for both different consumers and different situations.
Still, consumers will use these perceived values to evaluate a product’s price, so the com- pany must work to measure them. Sometimes, companies ask consumers how much they would pay for a basic product and for each benefit added to the offer. Or a company might conduct experiments to test the perceived value of different product offers. According to an FIGURE 9.2
Value-based pricing versus cost-based pricing
Source: Nagle, Thomas;
Holden, Reed, The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making, 3rd, © 2002. Printed and Electronically reproduced by permission of Pearson Education, Inc., Upper Saddle River, New Jersey.
old Russian proverb, there are two fools in every market – one who asks too much and one who asks too little. If the seller charges more than the buyers’ perceived value, the company’s sales will suffer. If the seller charges much less than buyers’ perceived value, its products sell very well, but they produce less revenue than they would if they were priced at the level of perceived value.
We now examine two types of value-based pricing: good value pricing and value-added pricing.
Good value pricing
During the past decade, marketers have noted a fundamental shift in consumer attitudes towards price and quality. Many companies have changed their pricing approaches to bring them into line with changing economic conditions and consumer price perceptions. More and more, marketers have adopted good value pricing strategies – offering just the right combination of quality and good service at a fair price.
In many cases, this has involved introducing less expensive versions of established, brand name products. For example, Armani offers the less expensive, more casual Armani Exchange fashion line. In other cases, good value pricing has involved redesigning existing brands to offer more quality for a given price or the same quality for less.
An important type of good value pricing at the retail level is everyday low pricing (EDLP).
EDLP involves charging a constant, everyday low price with few or no temporary price dis- counts. In contrast, high–low pricing involves charging higher prices on an everyday basis but running frequent promotions to lower prices temporarily on selected items. Think of any recent TV adverts you’ve seen for sofas – most likely heavy discounts were flagged to get attention. In recent years, high–low pricing has given way to EDLP in retail settings, ranging from Peugeot car dealerships to Carrefour or Tesco supermarkets, to upmarket department stores such as John Lewis.
Value-added pricing
In many business-to-business marketing situations, the challenge is to build the company’s pricing power – its power to escape price competition and to justify higher prices and mar- gins without losing market share. To do this, many companies adopt value-added pricing strategies. Rather than cutting prices to match competitors, they attach value-added features and services to differentiate their offers and thus support higher prices.
When a company finds its major competitors offering a similar product at a lower price, the natural tendency is to try to match or beat that price. Although the idea of undercutting a competitor’s prices and watching customers flock in is tempting, there are dangers. Price cutting can lead to price wars that erode the profit margins of all competitors in an industry. Or worse, discounting a product can cheapen it in the minds of customers. This greatly reduces the seller’s power to maintain profitable prices in the long term.
So, how can a company keep its pricing power when a competitor undercuts its price?
Often, the best strategy is not to price below the competitor, but rather to price above and convince customers that the product is worth it. The company should ask, ‘What is the value of the product to the customer?’, then stand up for what the product is worth. In this way, the company shifts the focus from price to value. ‘Even in today’s economic environment, it’s not about price,’ says a pricing expert. ‘It’s about keeping customers loyal by providing service they can’t find anywhere else.’6 A past master at value-added marketing is the German kitchen fixtures and fittings specialist Miele:
The motto at Miele is ‘Immer Besser’ which translated means ‘Forever Better’. This motto was conceived over 100 years ago by the founders and remains our company motto today, permeating through every aspect of our business. We pride ourselves on having the best products with unsurpassed quality and below are the elements that really set out the Miele difference.
Quality and reliability:
● All products are designed for 20 years’ use.
● Products are subjected to rigorous endurance testing during development.
● Every product we produce goes through an end line test before passing quality control.
● Many products are then randomly checked against further quality criteria.
● Strict quality control for us means peace of mind for you.
Performance:
● Miele is consistently independently tested in many product categories and consistently comes out on top.
● Whether its washing dishes, clothes or cooking a meal, Miele products deliver optimal results no matter how big or small the task.
● What’s more, optimal results are married with gentle performance, which is vital for good fabric care and glassware for example.7
So, that is what Miele itself has to say, but what independent evidence is there that it delivers enhanced value to customers, and that customers are prepared to pay for it? Well, the UK independent consumer testing organisation Which? made Miele its ‘best domestic appliance brand’ for the fifth time in 2013. In fact, virtually every Miele product tested by Which? wins the coveted title of a Which? ‘Best Buy’. It is the quality of the build and the reliability and performance of its products that enable Miele to charge premium prices. For example, you can buy many brands of washing machine, such as Beko, Hoover or Servis, for around €200. But if you want a Miele, you will have to pay considerably more; even if you shop around, you are unlikely to find one priced below €500. Miele delivers better value to the customer, and customers are prepared to pay for it.8
Company and product costs
Whereas customer value perceptions set the price ceiling, costs set the floor for the price that the company can charge. The company wants to charge a price that both covers all its costs for producing, distributing and selling the product, and delivers a fair rate of return for its effort and risk. A company’s costs may be an important element in its pricing strat- egy. Many companies, such as Ryanair and Aldi, work to become the ‘low-cost producers’
in their industries. Companies with lower costs can set lower prices that result in greater sales and profits.
The emphasis at Miele is on delivering products with excellent quality and reliability that justify a price premium over other brands. Independent customer test organisations consistently give Miele products the highest ratings
Source: Miele.
Types of costs
A company’s costs take two forms, fixed and variable. Fixed costs (also known as over- heads) are costs that do not vary with production or sales level. For example, a company must pay each month’s bills for rent, heating, interest and managerial salaries, whatever the company’s output. Variable costs vary directly with the level of production. Each PC produced by Dell involves a cost of microprocessors, wires, plastic, packaging and other inputs. These costs tend to be the same for each unit of the same model produced. They are called variable because their total varies with the number of units produced – the more computers produced, the higher the variable costs. Total costs are the sum of the fixed and variable costs for any given level of production. Management wants to charge a price that will at least cover the total production costs at a given level of production.
The company must watch its costs carefully. If it costs the company more than competi- tors to produce and sell its product, the company will have to charge a higher price or make less profit, putting it at a competitive disadvantage.
Cost-based pricing
The simplest pricing method is cost-plus pricing – adding a standard mark-up to the cost of the product. For example, an electrical retailer might pay a manufacturer €20 for a toaster and mark it up to sell at €30, a 50 per cent mark-up on cost. The retailer’s gross margin is
€10. If the store’s operating costs amount to €8 per toaster sold, the retailer’s profit margin will be €2.
The manufacturer that made the toaster probably used cost-plus pricing. If the manu- facturer’s standard cost of producing the toaster was €16, it might have added a 25 per cent mark-up, setting the price to the retailers at €20. Similarly, construction companies submit job bids by estimating the total project cost and adding a standard mark-up for profit. Lawyers, accountants, architects and other professionals typically price by adding a standard mark-up to their costs. Some sellers tell their customers they will charge cost plus a specified mark-up; for example, aerospace companies price this way to the government.
Using standard mark-ups to set prices is generally not a good idea. Any pricing method that ignores customer value and competitor prices is not likely to lead to the best price. Still, mark-up pricing remains popular for many reasons. First, sellers are more certain about costs than about customer value perceptions and demand. By tying the price to cost, sell- ers simplify pricing – they do not have to make frequent adjustments as demand changes.
Second, when all firms in the industry use this pricing method, prices tend to be similar and price competition is thus minimised. Third, many people feel that cost-plus pricing is fairer to both buyers and sellers. Sellers earn a fair return on their investment but do not take advantage of buyers by raising prices when buyers’ demand is very high.
Another cost-oriented pricing approach is break-even pricing, or a variation called target profit pricing. The firm tries to determine the price at which it will break even or make the target profit it is seeking. Target pricing uses the concept of a break-even chart, which shows the total cost and total revenue expected at different sales volume levels. Figure 9.3 shows a break-even chart for the toaster manufacturer discussed here. Fixed costs are €6m regardless of sales volume, and variable costs are €5 per unit. Variable costs are added to fixed costs to form total costs, which rise with volume. The slope of the total revenue curve reflects the price. Here, the price is €15 (e.g. the company’s revenue is €12m on 800,000 units, or €15 per unit).
At the €15 price, the company must sell at least 600,000 units to break even (break-even volume = fixed costs ÷ (price − variable costs) = €6,000,000 ÷ (€15 − €5) = 600,000). That is, at this level, total revenues will equal total costs of €9m. If the company wants a target profit of €2m, it must sell at least 800,000 units to obtain the €12m of total revenue needed to cover the costs of €10m plus the €2m of target profits. In contrast, if the company charges a higher price, say €20, it will not need to sell as many units to break even or to achieve its target profit. In fact, the higher the price, the lower the company’s break-even point.
The major problem with this analysis, however, is that it fails to consider customer value and the relationship between price and demand. As the price increases, demand decreases, and the market may not buy even the lower volume needed to break even at the higher price.
For example, suppose the company calculates that, given its current fixed and variable costs, it must charge a price of €30 for the product in order to earn its desired target profit.
But marketing research shows that few consumers will pay more than €25. In this case, the company will have to reduce its costs in order to lower the break-even point so that it can charge the lower price consumers expect.
Thus, although break-even analysis and target profit pricing can help the company to determine minimum prices needed to cover expected costs and profits, they do not take the price–demand relationship into account. When using this method, the company must also consider the impact of price on sales volume needed to realise target profits and the likeli- hood that the needed volume will be achieved at each possible price.
Other internal and external considerations affecting price decisions
Customer perceptions of value set the upper limit for prices, and costs set the lower limit.
However, in setting prices within these limits, the company must consider a number of other internal and external factors. Internal factors affecting pricing include the company’s overall marketing strategy, objectives and marketing mix, as well as other organisational considera- tions. External factors include the nature of the market and demand, competitors’ strategies and prices, and other environmental factors.
Overall marketing strategy, objectives and mix
Price is only one element of the company’s broader marketing strategy. Thus, before set- ting price, the company must decide on its overall marketing strategy for the product or service. If the company has selected its target market and positioning carefully, then its marketing mix strategy, including price, will be fairly straightforward. For example, when Toyota developed its Lexus brands to compete with German luxury performance cars in the higher income segment, this required charging a high price. In contrast, when it introduced its Aygo model, a small car with excellent fuel economy and low running costs aimed at budget-conscious car buyers, this positioning required charging a low price. Thus, pricing strategy is heavily influenced by decisions on market positioning.
General pricing objectives might include survival, current profit maximisation, market- share leadership, or customer retention and relationship building. At a more specific level, a FIGURE 9.3
Break-even chart for determining price
company can set prices to attract new customers or to retain profitably existing ones. It can set prices low to prevent competition from entering the market or set prices at competitors’
levels to stabilise the market. It can price to keep the loyalty and support of resellers or to avoid government intervention. Prices can be reduced temporarily to create excitement for a brand. Or one product may be priced to help the sales of other products in the company’s line. Thus, pricing may play an important role in helping to accomplish the company’s objectives at many levels.
Price is only one of the marketing mix tools that a company uses to achieve its marketing objectives. Price decisions must be coordinated with product design, distribution and pro- motion decisions to form a consistent and effective marketing programme. Decisions made for other marketing mix variables may affect pricing decisions. For example, a decision to position the product on high-performance quality will mean that the seller must charge a higher price to cover higher costs. And producers whose resellers are expected to support and promote their products may have to build larger reseller margins into their prices.
Companies often position their products on price and then tailor other marketing mix decisions to the prices they want to charge. Here, price is a crucial product-positioning fac- tor that defines the product’s market, competition and design. Many firms support such price-positioning strategies with a technique called target costing, a potent strategic weapon.
Target costing reverses the usual process of first designing a new product, determining its cost and then asking, ‘Can we sell it for that?’ Instead, it starts with an ideal selling price based on customer value considerations, and then targets costs that will ensure that the price is met.
Other companies de-emphasise price and use other marketing mix tools to create non- price positions. Often, the best strategy is not to charge the lowest price, but rather to differentiate the marketing offer to make it worth a higher price. For example, Sony builds more value into its consumer electronics products and charges a higher price than many competitors. Customers recognise Sony’s higher quality and are willing to pay more to get it. Some marketers even feature high prices as part of their positioning (see Marketing at Work 9.1). For example, Belgian beer brand Stella Artois has long been advertised as ‘reas- suringly expensive’, with the ‘expensive’ image of the brand designed to convey both quality and European sophistication to the customer.
Recently Media magazine reported on the market for luxury watches in China. The prospects are good: ‘Having a Swiss-made watch clasped around one’s wrist is a talis- man of attainment for Chinese men. A watch is a must,’
says Sandy Chen, Research Director, TNS China. ‘When buying up, they start with a luxury watch, next comes the luxury car, and last is the luxury apartment. Men com- pare and discuss watches, and they need a watch of a certain quality to be part of the social circle.’ The most aspirational brand in this very aspirational market? Rolex.
Apparently, if you want to demonstrate your success in the world’s second-largest (and soon to be largest) econ- omy, then nothing beats a Rolex watch. This is good news for luxury goods manufacturers in general, and for Rolex SA in particular, at a time when the European market for luxury goods looks like stagnating in the face of poor
prospects for long-term growth. The fast-growing Asian economies are showing a craving for the very best brands that Europe can offer.
One branding expert claims that, ‘If there were a fight to be the perfect brand, Rolex could be the heavyweight titleholder.’ After all, the simple function of telling the time can be served extremely well by more or less any watch costing more than a few euros these days. More complex functions can be delivered by, say, a watch from one of those solid and dependable brands, Timex or Casio. For around €50 you can more or less carry a multi-function computer on your wrist that will tell you the time in sev- eral time zones, light up at night, and capture multiple lap times on your jog round the park. Agreed, there are some people who will not find these utilitarian products all that attractive, but for the style conscious there are
Rolex: much more than just a watch MARKETING