Chapter 19 - The Marketing Mix, Product and Price
Learning Objectives: To understand the most common methods of pricing goods and services
You should now be familiar with the Product Life Cycle, the Product Portfolio Analysis, as well as the impact of the different stages on Cash Flow:
We now start the discussion of the second element of the Marketing Mix: Price!
Price is an important marketing decision:
It determines the value added;
It impacts demand and therefore influences on revenues and profits;
It helps establishing the psychological image and identity of a product.
How do you think companies determine the price of their products?
There are different variables and factors to be considered when setting up prices:
Cost of Production:
- Pricing decisions need to consider fixed and variable costs of production;
The level of Competition in the Market:
- The more competition in the market the more likely prices will be set similarly;
- Prices tend to be higher in monopolistic markets;
- A distinctive USP is needed for pricing products differently than the competition.
Business and Marketing Objectives:
- If the objective is to increase market share the price might be one;
- If the objective is to become recognized as a luxury premium brand the price might be another;
Old vs. New Products:
- Newer products (at launch) sometimes can benefit of higher prices;
- Products that have been around for longer may suffer a decrease in price.
Price Elasticity of Demand:
- Products with inelastic demand may be more prone to price increases with little impact on demand;
- Products with elastic demand may suffer a greater decrease in demand with increase in prices.
Business in Action 19.2 - 2 Minutes Discussion
Businesses can implement several different pricing methods to their products - such methods are divided into two categories:
Cost-Based Pricing:
- Mark-Up Pricing;
- Target Pricing;
- Full-Cost Pricing (Absorption Pricing);
- Contribution-Cost Pricing (Marginal-Cost Pricing);
Market/Competition Based Pricing:
- Market Oriented Pricing;
- Perceived Value Pricing;
- Pricing Discrimination;
- Dynamic Pricing.
Let's start by understanding Cost-Based Pricing methods:
- Mark-Up Pricing: adding a mark-up (%) on the top of the price paid for the product from the producer depending on the demand, brand, # of competitors, etc.;
- Mostly used by retailers.
Example Mark-Up Pricing:
- Product Total Cost = $40
- 50% Mark-up on Cost = $20
- Selling Price = $60
- Cost-Plus Pricing: Adding a fixed mark-up profit margin on the top of the product total unit manufacturing cost;
- Used by manufacturing companies.
- It’s challenging because assigning fixed costs for a product is not an easy task;
- Even more challenging when a wide variety of products is made by the same company;
Example:
- A business makes industrial training films and the annual fixed costs are $10 000.
- The variable cost of producing each film is $5.
- The business is currently producing 5 000 units per year.
The total costs of this product each year are: $10 000 + (5 000 × $5) = $35 000
The average or unit cost of making each film is: $35 000/5 000 = $7
- The business will have to charge at least $7 for each film in order to break even.
- If a 300% profit mark-up is added, then the total selling price becomes $28.
Contribution Cost (Marginal Cost):
- Based on the unit variable cost of the product (not fixed, not total);
- The firm will add an extra amount (contribution) on the top of the variable costs to cover for the fixed costs and then return a profit.
- Many businesses that have excess capacity use contribution-cost pricing to attract extra demand that will absorb the excess capacity. Here is how and why:
Example:
- A business produces a single product that has variable costs of $2 per unit.
- The total fixed costs of the firm are $40 000 per year.
- The business wants each unit sold to make a contribution of $1.
- The selling price is therefore $3. Every unit sold makes a contribution towards the fixed costs of $1.
- If the firm sells 40 000 units in the year, then the fixed costs will be covered.
- Every unit sold over 40 000 will mean the business makes a profit.
-If the firm sells 60 000 units, then the fixed costs will be covered and a $20 000 profit will be made.
Loss Leaders:
- Setting some products' prices low (lower than variable cost - negative contribution) to attract customers in the hope they will buy other and profitable products.
Let's now dive in to the different forms of Competition-Based Pricing, approach used when:
Avoiding a price war is the goal;
Driving a competitor out of the market is the goal (destroyer pricing);
Price leadership is in place and other companies simply follow the dominant's price.
Competition-Based Pricing is related to Market-Oriented Pricing in which studying the conditions of the market is necessary. Several strategies are part of such approach:
Price Discrimination:
- Charging different groups of customers different prices for the same product:
- Example: Different prices in different countries for the same product;
- Example: Setting cheaper prices for train tickets to children;
- Example: Lower prices for children in the movies theater.
Dynamic Pricing:
- Constant changing prices when selling goods to different customers;
- Based on demand as well as...
- Based on the pattern of consumption and ability to pay;
- Example: airlines.
Both, dynamic pricing and discrimination pricing have one big disadvantage: if customers realize different prices are being charged it can lead to a backlash.
There are two additional strategies we need to discuss and these are targeted specifically to new products and/or introduction of existing products to new markets:
Penetration Pricing: setting low prices to gain market share and slowly increases it as the market share objective is reached;
Market Skimming: setting high initial price at product launch (due to differentiation and/or customer willingness to pay premium) and decreases it overtime as competitors catch up or “early-buyers” cease.
Consider a few other issues in pricing decisions - food for evaluation:
Competitive industries have more averaged prices (easy to enter and with low level of differentiation);
Monopolistic companies (industries high entry barriers) can charge higher;
Oligopolies may go in to: price-wars; non-price competition (technology, marketing, brand); or collusion (illegal/fines).
Different strategies may be adopted by the same firm depending on market conditions, competition, costs);
Pricing decisions have a high impact on customer behavior (demand) - it's advised to back them up with market research;
Pricing is just one factor of the customer assessment of good value: offering good value and seamless integration of all aspects of the marketing mix is as important (lower is not always best).
To-Do-List:
Data Response Question #4 - Dell
Chapter 18 - The Marketing Mix, Product and Price
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