A base price can be lowered using discounts and the related tactics of allowances, rebates, low or zero percent financing, and value-based pricing. Managers use the various forms of discounts to encourage customers to do what they would not ordi- narily do, such as paying cash rather than using credit, taking delivery out of sea- son, or performing certain functions within a distribution channel.16 The following are of the most common tactics:
• Quantity discounts: When buyers get a lower price for buying in multiple units or above a specified dollar amount, they are receiving a quantity discount. A cumulative quantity discount is a deduction from list price that applies to the buyer’s total purchases made during a specific period; it is intended to en- courage customer loyalty. In contrast, a noncumulative quantity discount is a deduction from list price that applies to a single order rather than to the total volume of orders placed during a certain period. It is intended to encourage orders in large quantities.
• Cash discounts: A cash discount is a price reduction offered to a consumer, an industrial user, or a marketing intermediary in return for prompt payment of a bill. Prompt payment saves the seller carrying charges and billing expenses and allows the seller to avoid bad debt.
• Functional discounts: When distribution channel intermediaries, such as whole- salers or retailers, perform a service or function for the manufacturer, they must be compensated. This compensation, typically a percentage discount from the base price, is called a functional discount (or trade discount). Func- tional discounts vary greatly from channel to channel, depending on the tasks performed by the intermediary.
• Seasonal discounts: A seasonal discount is a price reduction for buying mer- chandise out of season. It shifts the storage function to the purchaser. Seasonal discounts also enable manufacturers to maintain a steady production schedule year-round.
base price
The general price level at which the company expects to sell the good or service.
quantity discount
A price reduction offered to buy- ers buying in multiple units or above a specified dollar amount.
cumulative quantity discount A deduction from list price that applies to the buyer’s total pur- chases made during a specific period.
noncumulative quantity dis- count
A deduction from list price that applies to a single order rather than to the total volume of orders placed during a certain period.
cash discount
A price reduction offered to a consumer, an industrial user, or a marketing intermediary in return for prompt payment of a bill.
functional discount (trade discount)
A discount to wholesalers and retailers for performing channel functions.
seasonal discount
A price reduction for buying mer- chandise out of season.
base price
The general price level at which the company expects to sell the good or service.
quantity discount
A price reduction offered to buy- ers buying in multiple units or above a specified dollar amount.
cumulative quantity discount A deduction from list price that applies to the buyer’s total pur- chases made during a specific period.
noncumulative quantity dis- count
A deduction from list price that applies to a single order rather than to the total volume of orders placed during a certain period.
cash discount
A price reduction offered to a consumer, an industrial user, or a marketing intermediary in return for prompt payment of a bill.
functional discount (trade discount)
A discount to wholesalers and retailers for performing channel functions.
seasonal discount
A price reduction for buying mer- chandise out of season.
Pricing Decisions
• Promotional allowances: A promotional allowance (also known as a trade allowance) is a payment to a dealer for promoting the manufacturer’s products. It is both a pricing tool and a promotional device. As a pricing tool, a promotional allowance is like a functional discount. If, for example, a retailer runs an ad for a manufacturer’s product, the manufacturer may pay half the cost. If a retailer sets up a special display, the manufacturer may include a certain quantity of free goods in the retailer’s next order.17
• Rebates: A rebate is a cash refund given for the purchase of a product during a specific period. The advantage of a rebate over a simple price reduction for stimulating demand is that a rebate is a temporary inducement that can be taken away without altering the basic price structure. A manufacturer that uses a simple price reduction for a short time may meet resistance when trying to restore the price to its original, higher level. Fully 40 percent of all rebates never get redeemed because consumers fail to apply for them or their applications are rejected.18 Also, complex rules, filing periods of as little as a week, repeated requests for copies of receipts, and long delays in sending out checks discourage consumers from even attempting to retrieve their money.
That translates into more than $2 billion of extra revenue for retailers and their suppliers each year. What rebates do is get consumers to focus on the discounted price of a product, then buy it at full price. “The game is obviously that anything less than 100 percent redemption is free money,” says Paula Rosenblum, director of retail research at consulting firm Aberdeen Group Inc.19 The quest for consumers who never file for a rebate has resulted in new ter- minology. Purchases by consumers who never file for their rebates are called
“breakage.” Wireless companies that pay 100 percent rebates on some cell phones, for example, rely in part on “breakage” to make money. Rebate checks that are never cashed are called “slippage.”
• Zero percent financing: During the early and mid-2000s, new-car sales needed a boost. To get people back into automobile showrooms, manufacturers of- fered zero percent financing, which enabled purchasers to borrow money to pay for new cars without incurring an interest charge. The tactic created a huge increase in sales but not without cost to the manufacturers. A five-year interest-free car loan represented a cost of over $3,000 on a typical vehicle sold during the zero percent promotion. Automakers were still offering such incentives in 2007.
• Markdown money: For decades, department stores have expected clothing companies and other merchandise suppliers to share in their sales risk.
Whenever a suit or a sweater doesn’t sell at full price, it is marked down.
Department stores have required vendors to absorb some of the cost by paying the retailers markdown money at the end of each season. It’s a per- petual negotiation in which each side moans that the other isn’t shouldering enough of the risk. But recently, as department stores struggle for survival against discounters and specialty chains, vendors say certain retailers have been pushing too hard, relying too much on markdowns to move merchan- dise and demanding higher rebates than what were originally agreed upon.
Critics say markdown allowances, while legal, create an uneven playing field for vendors. Some big, powerful suppliers hold more sway with retailers and might pay lower allowances, creating an unfair advantage over smaller ones, according to some smaller vendors. Markdown money may be onerous for suppliers, but most have no choice but to “comply because they need the business,” said Madison Riley, a principal at Kurt Salmon Associates, a consumer products consulting company. “If a vendor can’t help a depart- ment store improve its profit margins, department stores have plenty of alternatives.”20
promotional allowance (trade allowance) A payment to a dealer for promoting the manufacturer’s products.
rebate
A cash refund given for the purchase of a product during a specific period.
markdown money
A payment by a manufacturer to a retailer to help cover the costs of markdowns that the retailer had to take.
promotional allowance (trade allowance) A payment to a dealer for promoting the manufacturer’s products.
rebate
A cash refund given for the purchase of a product during a specific period.
markdown money
A payment by a manufacturer to a retailer to help cover the costs of markdowns that the retailer had to take.
Setting the Right Price Chapter 20
Value-Based Pricing
Value-based pricing, also called value pricing, is a pricing strategy that has grown out of the quality movement. Instead of figuring prices based on costs or competitors’
prices, it starts with the customer, considers the competition, and then determines the appropriate price. The basic assumption is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers. Because very few firms operate in a pure monopoly, however, a marketer using value-based pricing must also determine the value of competitive offerings to customers. Customers determine the value of a prod- uct (not just its price) relative to the value of alternatives. In value-based pricing, there- fore, the price of the product is set at a level that seems to the customer to be a good price compared with the prices of other options.
When two Wal-Mart Supercenters and a rival regional grocery opened near a Kroger supermarket in Houston, the Kroger’s sales dropped 10 percent.
The store manager moved quickly to slash some prices and cut labor costs, for example, by buying ready-made cakes instead of baking them in-house and ordering precut salad-bar items from suppliers. Kroger employees used to stack displays by hand; now fruit and vegetables arrive stacked for display.
Such moves have helped Kroger cut worker-hours by 30 to 40 percent over the last four years and lower the prices of staples such as cereal, bread, milk, eggs, and disposable diapers. If Wal-Mart’s Supercenters continue to expand at their current pace, however, within this decade, more than three-quar- ters of the nation’s Kroger’s and Albertson’s stores and more than half the Safeway outlets could be within ten miles of a Wal-Mart Supercenter.
The fight for the minds of customers is already having an impact. Shoppers in competitive markets are seeing prices fall as Wal-Mart pushes rivals to match its value prices. Recently, a number of regional grocery chains have switched to value pricing.
In the past, they offered weekly specials to attract shoppers and then made up the lost profit by keeping nonsale prices substantially higher. Now, stores like Costco and Wal- Mart have conditioned consumers to expect inexpensive goods every day.
Ethan Allen Interiors, the furniture retailer, recently dropped its six or seven sales events each year and moved to value pricing. All retail prices are roughly 7 percent lower than the previous year. Value pricing has also eliminated some pro- duction bottlenecks and inefficiencies caused by sales-driven order surges. Despite a move to value pricing, Ethan Allen has had trouble gaining market share. Critics say price cuts haven’t gone far enough. Large Chinese manufacturers are producing Ethan Allen-quality products at much lower price points.21
Pricing Products Too Low
Sometimes managers price their products too low, thereby reducing company prof- its.22 This seems to happen for two reasons. First, managers attempt to buy market share through aggressive pricing. Usually, however, these price cuts are quickly met by competitors. Thus, any gain in market share is short-lived, and overall industry profits end up falling. Second, managers have a natural tendency to want to make decisions that can be justified objectively. The problem is that companies often lack hard data on the complex determinants of profitability, such as the relation- ship between price changes and sales volumes, the link between demand levels and costs, and the likely responses of competitors to price changes. In contrast, compa- nies usually have rich, unambiguous information on costs, sales, market share, and competitors’ prices. As a result, managers tend to make pricing decisions based on current costs, projected short-term share gains, or current competitor prices rather than on long-term profitability.
The problem of “underpricing” can be solved by linking information about price, cost, and demand within the same decision support system. The demand data can be developed via marketing research. This will enable managers to get the hard data they need to calculate the effects of pricing decisions on profitability.
value-based pricing Setting the price at a level that seems to the customer to be a good price compared to the prices of other options.
value-based pricing Setting the price at a level that seems to the customer to be a good price compared to the prices of other options.
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Pricing Decisions