When a purchase decision involves great uncertainty, consumers tend to rely on a high price as a predictor of good quality. Reliance on price as an indicator of qual- ity seems to occur for all products, but it reveals itself more strongly for some items than for others.21 Among the products that benefit from this phenomenon are cof- fee, stockings, aspirin, salt, floor wax, shampoo, clothing, furniture, perfume, whis-
key, and many services. In the absence of other information, people typically assume that prices are higher because the products contain better materi- als, because they are made more carefully, or, in the case of pro- fessional services, because the provider has more expertise. In other words, consumers assume that “You get what you pay for.”
Research has found that products that are perceived to be of high quality tend to ben- efit more from price promotions than products perceived to be of lower quality.22 However, when perceived high- and lower-qual- ity products are offered in set- tings where consumers have difficulty making comparisons, then price promotions have an equal effect on sales. Compari- sons are more difficult in end- of-aisle displays, feature adver- tising, and the like.
Knowledgeable merchants take these consumer attitudes into account when devising their pricing strategies. Prestige pricing is charging a high price to help promote a high-quality prestige pricing
Charging a high price to help pro- mote a high-quality image.
prestige pricing
Charging a high price to help pro- mote a high-quality image.
REVIEW LEARNING OUTCOME
Demonstrate how the product life cycle, competition, distribution and promotion strategies, customer demands, the Internet, and perceptions of quality can affect pricea
LO 1
– Other firms enter market – Price wars Introduction
Growth Maturity Decline
– Convenience – Selling against the brand – Exclusive distribution – Consumers
use shopping bots to hunt for bargains – Increased competition – Internet auctions Price used as
a promotional tool
– Large customers pressure suppliers for price reductions and guaranteed margins
– Uncertain consumers tend to rely on price to indicate quality ("You get what you pay for.")
Price
Internet and extranets
Distribution Competition PLC
Price/quality relationship
Demands of large customers
Promotion strategy
Review And Applications
Discuss the importance of pricing decisions to the economy and to the individual firm. Pricing plays an integral role in the U.S. economy by allocating goods and services among consumers, governments, and businesses. Pricing is essential in business because it creates revenue, which is the basis of all business activity. In setting prices, marketing managers strive to find a level high enough to produce a satisfactory profit.
1.1 Why is pricing so important to the marketing manager?
1.2 How does price allocate goods and services?
List and explain a variety of pricing objectives. Establishing realistic and measurable pricing objectives is a critical part of any firm’s marketing strategy. Pricing objectives are commonly clas- sified into three categories: profit oriented, sales oriented, and status quo. Profit-oriented pricing is based on profit maximization, a satisfactory level of profit, or a target return on investment. The goal of profit maximization is to generate as much revenue as possible in relation to cost. Often, a more practical approach than profit maximization is setting prices to produce profits that will satisfy management and stockholders. The most common profit-oriented strategy is pricing for a specific return on investment relative to a firm’s assets. The second type of pricing objective is sales oriented, and it focuses on either maintaining a percentage share of the market or maxi- mizing dollar or unit sales. The third type of pricing objective aims to maintain the status quo by matching competitors’ prices.
2.1 Give an example of each major type of pricing objective.
2.2 Why do many firms not maximize profits?
LO 1 LO 1
LO 2 LO 2
Pricing Concepts Chapter 19
image. A successful prestige pricing strategy requires a retail price that is reasonably consistent with consumers’ expectations. No one goes shopping at a Gucci’s shop in New York and expects to pay $9.95 for a pair of loafers. In fact, demand would fall drastically at such a low price. Bayer aspirin would probably lose market share over the long run if it lowered its prices. A new mustard packaged in a crockery jar was not successful until its price was doubled.
Some of the latest research on price-quality relationships has focused on con- sumer durable goods. The researchers first conducted a study to ascertain the dimensions of quality. These are (1) ease of use; (2) versatility (the ability of a prod- uct to perform more functions, e.g., special stitch types on sewing machines, or be more flexible, e.g., continuous temperature controls on microwave ovens); (3) dura- bility; (4) serviceability (ease of obtaining quality repairs); (5) performance; and (6) prestige. The researchers found that when consumers focused on prestige and/
or durability to assess quality, price was a strong indicator of perceived overall quality. Price was less important as an indicator of quality if the consumer was focusing on one of the other four dimensions of quality.23
a satisfactory profi t in a high-risk industry >
< jobs slashed by Freightliner to cut costs
used cars inspected annually in Nevada >
price of a Rolling Stones concert ticket>
< price levels at Allstate price decrease for safe
drivers and increase for unsafe drivers >
Ryanair’s percent profi t margin >
<price markup used by
small-retailers
35% $400
1,500
100%
20%
8,000
400,000
22
Pricing Decisions
Explain the role of demand in price determination. Demand is a key determinant of price. When establishing prices, a firm must first determine demand for its product. A typical demand schedule shows an inverse relationship between quantity demanded and price: When price is lowered, sales increase; and when price is increased, the quantity demanded falls. For prestige products, however, there may be a direct relationship between demand and price: the quantity demanded will increase as price increases.
Marketing managers must also consider demand elasticity when setting prices. Elasticity of demand is the degree to which the quantity demanded fluctuates with changes in price. If consumers are sensitive to changes in price, demand is elastic; if they are insensitive to price changes, demand is inelastic. Thus, an increase in price will result in lower sales for an elastic product and little or no loss in sales for an inelastic product. Inelastic demand creates pricing power.
3.1 Explain the role of supply and demand in determining price.
3.2 If a firm can increase its total revenue by raising its price, shouldn’t it do so?
3.3 Explain the concepts of elastic and inelastic demand. Why should managers understand these concepts?
Understand the concept of yield management systems and targeting technology. Yield manage- ment systems use complex mathematical software to profitably fill unused capacity. The software uses techniques such as discounting early purchases, limiting early sales at these discounted prices, and overbooking capacity. These systems are used in service and retail businesses and are substantially rais- ing revenues. The use of Internet cookies and targeting software enables online retailers to offer different pricing and promotional offers to online buyers based upon their online shopping and browsing habits.
4.1 Why are so many companies adopting yield management systems?
4.2 Explain the relationship between supply and demand and yield management systems.
4.3 Why is targeting technology so effective?
Describe cost-oriented pricing strategies. The other major determinant of price is cost. Market- ers use several cost-oriented pricing strategies. To cover their own expenses and obtain a profit, wholesalers and retailers commonly use markup pricing: They tack an extra amount onto the manufacturer’s original price to cover their costs and earn a profit. Another pricing technique is to maximize profits by setting price where marginal revenue equals marginal cost. Still another pricing strategy determines how much a firm must sell to break even and uses this amount as a reference point for adjusting price.
5.1 Your firm has based its pricing strictly on cost in the past. As the newly hired marketing manager, you believe this policy should change. Write the president a memo explaining your reasons.
5.2 Why is it important for managers to understand the concept of break-even points? Are there any drawbacks?
Demonstrate how the product life cycle, competition, distribution and promotion strategies, guaranteed price matching, customer demands, the Internet, and perceptions of quality can affect price. The price of a product normally changes as it moves through the life cycle and as demand for the product and competitive conditions change. Management often sets a high price at the introductory stage, and the high price tends to attract competition. The competition usually drives prices down because individual competitors lower prices to gain market share.
Adequate distribution for a new product can sometimes be obtained by offering a larger-than- usual profit margin to wholesalers and retailers. The Internet enables consumers to compare prod- ucts and prices quickly and efficiently. Price is also used as a promotional tool to attract customers.
Special low prices often attract new customers and entice existing customers to buy more. Price matching positions the retailer as a low price vendor. Firms that don’t match prices are perceived as offering a higher level of service. Large buyers can extract price concessions from vendors. Such demands can squeeze the profit margins of suppliers.
Perceptions of quality can also influence pricing strategies. A firm trying to project a presti- gious image often charges a premium price for a product. Consumers tend to equate high prices with high quality.
LO 3 LO 3
LO 4 LO 4
LO 5 LO 5
LO 6 LO 6
Pricing Concepts Chapter 19
6.1 Divide the class into teams of five. Each team will be assigned a different grocery store from a different chain. (An independent is fine.) Appoint a group leader. The group leaders should meet as a group and pick 15 nationally branded grocery items. Each item should be specifically described as to brand name and size of the package. Each team will then proceed to its assigned store and collect price data on the 15 items. The team should also gather price data on 15 similar store brands and 15 generics, if possible.
Each team should present its results to the class and discuss why there are price variations between stores, national brands, store brands, and generics.
As a next step, go back to your assigned store and share the overall results with the store manager. Bring back the manager’s comments and share them with the class.
6.2 How does the stage of a product’s life cycle affect price? Give some examples.
6.3 Go to Priceline.com (http://www.priceline.com). Can you research a ticket’s price before purchasing it? What products and services are available for purchasing? How com- fortable are you with naming your own price? Relate the supply and demand curves to customer-determined pricing.
Key Terms
average total cost (ATC) 580 average variable cost (AVC) 580
break-even analysis 583
demand 573
elastic demand 574
elasticity of demand 574
fixed cost 580
inelastic demand 574
keystoning 583
marginal cost (MC) 580
marginal revenue (MR) 583
market share 571
markup pricing 581
prestige pricing 590
price 568
price equilibrium 574
profit 568
profit maximization 583
return on investment (ROI) 570 revenue 568 selling against the brand 586
status quo pricing 572
supply 573
unitary elasticity 575
variable cost 580
yield management
systems (YMS) 578
Exercises
APPLICATION EXERCISE
Reliance on price as a predictor of quality seems to occur for all products. Does this mean that high-priced products are superior? Well, sometimes. Price can be a good predictor of quality for some products, but for others, price is not always the best way to determine the quality of a product or service before buying it. This exercise (and worksheet) will help you examine the price-quality relationship for a simple product: canned goods.24
Activities
1. Take a trip to a local supermarket where you are certain to find multiple brands of canned fruits and vegetables. Pick a single type of vegetable or fruit you like, such as cream corn or peach halves, and list five or six brands in the following worksheet:
Price (1)
Brand