Pricing and Sales Promotion:INTRODUCTION TO PRICING MANAGEMENT

1. INTRODUCTION TO PRICING MANAGEMENT

A husband and wife were interested in purchasing a new full-sized automobile. They found just what they were looking for, but its price was more than they could afford—$28,000. They then found a smaller model for $5,000 less that seemed to offer the features they wanted. However, they decided to look at some used cars and found a one-year-old full-size model with only 5,000 miles on it. The used car included almost a full warranty and was priced at $20,000. They could not overlook the $8,000 difference between their first choice and the similar one-year-old car and decided to purchase the used car.

This simple example illustrates an important aspect of pricing that often is not recognized: buyers respond to price differences rather than to specific prices. While this basic point about how prices influence buyers’ decisions may seem complex and not intuitive, it is this very point that drives how businesses are learning to set prices. You may reply that this couple was simply responding to the lower price of the used car. And you would be correct—up to a point. These buyers were responding to a relatively lower price, and it was the difference of $8,000 that eventually led them to buy a used car.

Now consider the automobile maker who has to set the price of new cars. This decision maker needs to consider how the price will compare (1) to prices for similar cars by other car makers; (2) with other models in the seller’s line of cars; and (3) with used car prices. The car maker also must consider whether the car dealers will be able to make a sufficient profit from selling the car to be motivated to promote the car in the local markets. Finally, if the number of new cars sold at the price set is insufficient to reach the profitability goals of the maker, price reductions in the form of cash rebates or special financing arrangements for buyers might have to be used. Besides these pricing decisions, the car maker must decide on the discount in the price to give to fleet buyers like car rental companies. Within one year, these new rental cars will be sold at special sales to dealers and to individuals like the buyer above.

Pricing a product or service is one of the most important decisions made by management. Pricing is the only marketing strategy variable that directly generates income. All other variables in the marketing mix—advertising and promotion, product development, selling effort, distribution—involve expenditures. The purpose of this chapter is to introduce this strategically important marketing de- cision variable, define it, and discuss some of the important ways that buyers may respond to prices. We will also discuss the major factors that must be considered when setting prices, as well as problems managers face when setting and managing prices.

The Definition of Price

It is usual to think of price as the amount of money we must give up to acquire something we desire. That is, we consider price as a formal ratio indicating the quantities of money (or goods and services) needed to acquire a given quantity of goods or services. However, it is useful to think of price as a ratio of what buyers receive in the way of goods and services relative to what they give up in the way of money or goods and services. In other words, price is the ratio of what is received relative to what is given up.

Thus, when the price of a pair of shoes is quoted as $85, the interpretation is that the seller receives $85 from the buyer and the buyer receives one pair of shoes. Similarly, the quotation of two shirts for $55 indicates the seller receives $55 and the buyer receives two shirts. Over time, a lengthy list of terms that are used instead of the term price has evolved. For example, we pay a postage rate to the Postal Service. Fees are paid to doctors and dentists. We pay premiums for insurance coverage, rent for apartments, tuition for education, and fares for taxis, buses, and airlines. Also, we pay tolls to cross a bridge, admission to go to a sporting event, concert, movie, or museum. Banks may have user fees for credit charges, minimum required balances for a checking account service, rents for safety deposit boxes, and fees or interest charges for automatic teller machine (ATM) use or cash advances. Moreover, in international marketing, tariffs and duties are paid to import goods into another country.

The problem that this variety of terms creates is that we often fail to recognize that the setting of a rent, interest rate, premium, fee, admission charge, or toll is a pricing decision exactly like that for the price of a product purchased in a store. Moreover, most organizations that must set these fees, rates, and so on must also make similar pricing decisions to that made by the car maker discussed above.

Proactive Pricing

The need for correct pricing decisions has become even more important as global competition has become more intense. Technological progress has widened the alternative uses of buyers’ money and time and has led to more substitute products and services. Organizations that have been successful in making profitable pricing decisions have been able to raise prices successfully or reduce prices without competitive retaliation. Through careful analysis of pertinent information and deliberate ac- quisition of relevant information, they have become successful pricing strategists and tacticians (Cressman 1997).

There are two essential prerequisites to becoming a successful proactive pricer. First, it is nec- essary to understand how pricing works. Because of the complexities of pricing in terms of its impact on suppliers, salespeople, distributors, competitors, and customers, companies that focus primarily on their internal costs often make serious pricing errors.

Second, it is essential for any pricer to understand the pricing environment. It is important to know how customers perceive prices and price changes. Most buyers do not have complete infor- mation about alternative choices and most buyers are not capable of perfectly processing the available information to arrive at the ‘‘optimum’’ choice. Often, price is used as an indicator not only of how much money the buyer must give up, but also of product or service quality. Moreover, differences between the prices of alternative choices also affect buyers’ perceptions. Thus, the price setter must know who makes the purchase decision for the products being priced and how these buyers perceive price information.

Factors to Consider When Setting Price

There are five essential factors to consider when setting price. Demand considerations provide a ceiling or maximum price that may be charged. This maximum price depends on the customers’ perceptions of value in the seller’s product or service offering. On the other hand, costs provide a floor or minimum possible price. For existing products or services, the relevant costs are those costs that are directly associated with the production, marketing, and distribution of these products or services. For a new product or service, the relevant costs are the future costs over that offering’s life. The difference between the maximum price that some buyers are willing to pay (value) and the minimum cost-based price represents an initial pricing discretion. However, this range of pricing discretion is narrowed by competition, corporate profit and market objectives, and regulatory con- straints.