Introduction to Pricing

MKTG 5200
 CUSTOMER ANALYSIS COMPETITOR ANALYSIS COMPANY ANALYSIS P.E.S.T. ANALYSIS
Statistics Direct / indirect competitors Objectives Political
Shopping / usage behavior Their current / previous strategies Strengths / weaknesses Economic
Buying process
Importance of this market to them Current / past performance Social
Likely actions and reactions Fit with other products Technological
SEGMENTATION
Possible segments
Size of segments
Growth potential
Analysis

DIFFERENTIATION IMPLICATIONS FOR

TARGET MARKETING STRATEGY
MARKET
Benefits valued by customer
SELECTION Product
Added value from specific
Price
combinations of benefits
Distribution channels
Promotion
- advertising
POSITION - sales force

Decisions
OUTCOMES
Financial
Other

Outcomes
Marketing Decision Framework
 Analysis

IMPLICATIONS FOR
MARKETING STRATEGY

Price

Decisions

Marketing Decision Framework (Showing Area of Outcomes

Focus for this Lecture)
What is price?
What Is Price?
• Money and/or other considerations exchanged for the
ownership or use of a good or service
A Unique Part of the Mix
• Price has several characteristics that distinguish it from
other elements of the marketing mix
– It has an immediate effect on profitability

– It can be changed quickly

– It tends to generate fast competitive reactions

A Unique Part of the Mix
• Price also serves as a signal of quality to customers, especially
when their knowledge of the product category is low…
– They have never purchased the product before
– They purchase the product infrequently
– Product design is continually changing
– Product quality or size varies considerably across stores
More than Just Sticker Price
• Sticker Price ≠ Cost to the Customer

• To your customer, “price” includes all the money, time and

energy they must expend to identify, locate and realize the
benefits of the product

• Sometimes, a significant proportion of these costs are

incurred long after the original purchase…
More than Just Sticker Price
Cost to the Customer
Sticker Price

Cost of taking possession

Financing costs
Insurance costs
Usage (e.g., gas) costs
Maintenance costs
Repair costs
Resale (depreciation) costs
Selling (disposal) costs
More than Just a Single Number
• Pricing dynamics:
Do you lower / raise prices over time?
– WestJet (entered market as discounter, but raised prices)
– High-tech products (introductory prices are high, but drop)

• Price discrimination:
Do you charge different prices to different people?
– Student / senior prices
– Time-based pricing (e.g., movie matinees, midweek flights, seasonal hotel rooms)
– Membership pricing / promotions (e.g., CAA discounts)
More than Just a Single Number
• Price discounting:
How much and how often?
– Level of discount
– Frequency of discounting
– Rationale for discount (e.g., volume buying, commitment to a contract)

• Multiple products:
Consider relative as well as absolute prices
– Gillette (razor vs. blades)
– P&G (various brands of laundry detergent)
More than Just a Single Number
• Bundling:
Price separately for each item, or sell in bundles?
– Air Canada (Aeroplan miles, seat selection, luggage, meals, etc.)
– Rogers / Bell

• Sticker price vs. Unit price:

Consumers may look at either, or both
– Small package sizes keep sticker price down, encourage trial
– Large packages minimize costs, encourage “customer lock-in”
End of Lecture
Setting Price
MKTG 5200
How do you set price?
You can’t just charge whatever you want…

WE’RE NOT CHANGING ANYTHING. WE

JUST WANTED TO CHARGE MORE.
Steps in Setting Price
1. Set your price objective

2. Assess demand

3. Estimate your costs

4. Consider competitors

5. Select pricing method

6. Select final price

1. Set Your Pricing Objectives
• The ‘optimal’ pricing strategy depends on your marketing
and strategic goals:
– Earn a quick profit
– Increase market share
– Maximize sales volume
– Establish value leadership
– Survive
– Be socially responsible
2. Assess Demand
• How many units of your product can you reasonably expect to
sell, and how will that vary depending on the price you charge?

• The demand curve is a representation of the number of units

of a specific product that customers will buy at various prices

• It is the product of several factors:

– Customer tastes
– Customer income / financial resources
– Price and availability of other products
Illustrative demand curves for Newsweek magazine

Movement along
demand curve
as price rises from Movement along a demand
$1.50 to $2.00 curve depicts the change in
quantity demanded resulting
Quantity demanded from a change in price
At $1.50 per copy
Market demand (i.e., the
relationship between price
and sales) has not changed
Illustrative demand curves for Newsweek magazine

Shift of
demand curve
due to change in The shift depicted here
demand factors represents an overall
increase in market demand.
i.e., the quantity demanded
by the market is higher at
every price point
Price Elasticity of Demand
• The percent change in quantity demanded relative to a
percent change in price
High elasticity: Price changes have a significant effect on sales
(steep demand curve)

Low elasticity: Price changes have a minor effect on sales

(flat demand curve)
Illustrative demand curves for Newsweek magazine

What does it mean When a product has a high

if a product has price elasticity of demand,
inelastic demand High price elasticity a small decrease in price
(i.e., low price of demand leads to a significant
elasticity increase in sales.
of demand)?
Low price elasticity
Answer: of demand Likewise, a small price
increase will lead to a
Increases or decreases
major sales decline.
in price will have a
relatively small
impact on demand.
Factors that Contribute to Inelastic Demand
• Your product is distinctive
• Your product is necessary for daily living
• Your product has a limited shelf life / cannot be stored
• Substitutes are largely unknown and/or hard to compare
• Cost of the product is small relative to the consumer’s income
• Buyers are slow to change buying habits
• Buyers can justify higher prices (to themselves, others)
3. Estimate Your Costs
• Before settling on a pricing strategy, be sure to have a good
understanding of your costs
– Fixed costs: Expenses that do not change with the quantity of
product produced and sold
– Variable costs: Expenses that vary directly with the quantity of
product that is produced and sold
– Total cost: Total expense incurred in producing and marketing a
product (fixed costs + variable costs)
– Average cost: Total expense / units produced
Remember that unit costs usually drop as production levels rise
4. Consider Competitors
• What alternatives do customers look at when considering
your product?
• Do you offer something rival offerings don’t?
– Features? Service? Reliability? Image?
• How do you want to position your product / brand relative
to those rival offerings?
• Given this point of comparison, should your price be higher,
lower, or the same?
4. Consider Competitors
• Reviewing prices across your product lineup may suggest
opportunities to:
– Improve margins
– Reduce competitive risks
Competition-based pricing

High

Margin

Low
Competition-based pricing

High

Margin

Low
Low Vulnerability to High
Competition
Competition-based pricing

High

Margin

Low
Low Vulnerability to High
Competition
Competition-based pricing
Forgone profits

High

Margin

Low
Low Vulnerability to High
Competition
5. Select a Pricing Method
• Cost/Profit-based approaches
When the market price for a product is not well-established, many firms
base their pricing strategy on costs and internal profit goals:
– Cost-Plus / Markup Pricing: Determining the total unit cost of
providing a product or service and adding a specific amount or
percentage to arrive at a price
– Target-Profit Pricing: Setting prices with the aim of achieving a
specific annual profit target
– Target-ROI Pricing: Setting prices to achieve a specific
return-on-investment (ROI) target
5. Select a Pricing Method
• Market-based approaches
When there is a well-established price for your product in a particular
market, options include:
– Above-, At-, or Below-Market Pricing: Setting prices based on the
price of similar products in the market
– Target: Deliberately adjusting the composition and features of a
product in order to achieve a specific retail price
5. Select a Pricing Method
• Market-based approaches
When a product is new to market, and there is little or no established
pricing history, strategic considerations also come into play :
– Skim Pricing: Charging the highest initial price that customers who
really want the product are willing to pay
– Penetration Pricing: Setting a low initial price on a new product to
appeal immediately to the mass market
Skim or penetrate?

Skim pricing when… Penetration pricing when…

• Enough prospective customers are willing • Many segments of the market are price
to buy the product immediately at the high sensitive, so the product is unlikely to sell
initial price to make sales profitable well at a high price
• A high initial price will not attract • Low initial price discourages competitors
competitors to the market from entering the market
• Lowering price has only a minor effect on • Unit production and marketing costs fall
increasing sales volume and reducing unit dramatically as production volume
costs increases
• Customers interpret the high price as • Quality perceptions are not driven mainly
signifying high quality by price
Cost-Based vs. Market-Based Pricing

Source: Market-Based Management, 4e; Roger Best; Pearson Prentice Hall

6. Select the Final Price
• Consider your entire product portfolio…
– Price Lining: Pricing a line of products at a number of different
specific pricing points
Price Lining: Apple’s iPhone lineup
Price Lining: “Good, Better, Best” options at HubSpot
Price Lining: Class of service options at Air Canada
6. Select the Final Price
• Consider your entire product portfolio…
– Bundle Pricing: The marketing of two or more products in a
bundled “package” for a single price
Bundling: Rogers combines Internet, TV, and home phone
Bundling: The famous ‘Meal Deal’ at Boots
6. Select the Final Price
• Consider geography…
– FOB Origin Pricing: Customer takes delivery of the product at the
factory and is responsible for the costs and risks of shipping
– Uniform Delivered Pricing: Company charges the same price to
all customers regardless of location, setting freight charge based on
average freight cost
6. Select the Final Price
• Consider promotions…
Even after you set the ‘final price’, you may want to adjust your pricing
to achieve specific objectives:
– Quantity Discounts: To encourage volume buying
– Cash Discounts: To eliminate credit costs and risks
– Low-Interest Financing: To attract customers who
lack assets but have good cash flow
– Loss-Leader Pricing: To attract customers who are likely to buy other
complementary products
But Avoid the ‘Discount Trap’
GOOD NEWS! WE FINALLY
FOUND A WAY TO OFFER
DEEPER DISCOUNTS THAN
OUR COMPETITORS FOR BLACK
FRIDAY AND CYBER MONDAY.

I THINK WE CAN
GO DEEPER
End of Lecture
The Psychology of Pricing
MKTG 5200
Take a look a this retail display…
Psychology and Pricing
• A number of psychological phenomena are known to influence
consumer response to pricing strategies
• In this lecture, we’ll look at some of them…
– Perceptions of Price Differences
– Odd Endings
– Reference Prices
– Willingness to Pay
– Endowment Effects
– Framing Effects
Perceptions of
Price Differences
 MBA students
were asked this question…
Perceptions of Price Differences
Imagine you are the purchasing agent for a large company…

Last week, you ordered a Last week, you ordered

new notebook computer for the new notebook computers for the
sales department that costs sales department, totaling
$1,600. You then find that the $16,000. You then find that the
same notebook is available from same notebooks are available
another vendor for $1,200. from another vendor for $15,600.

The cost of switching is about The cost of switching is about

30 minutes of work. 30 minutes of work.

Do you switch? Do you switch?

Perceptions of Price Differences
Did you notice?

• Total savings in both Version 1 and Version 2 is identical

– Version 1: Single notebook computer
 Price dropped $400 (from $1,600 to $1,200)
How many MBA students
switched in each condition?
– Version 2: Multiple notebook computers
 Price dropped $400 (from $16,000 to $15,600)
Perceptions of Price Differences
• A similar study was conducted with executives with an
even more rigorous test…
– Version 1: Electric typewriter for $1000 vs. $600 $400 savings
40% savings
 89% switched

– Version 2: Word Processor for $100,000 vs. $96,000 $4,000 savings

4% savings
 52% switched
Perceptions of Price Differences
• Lessons?
1. Buyers often think about price differences in percentage
rather than absolute terms
2. Large percentage discounts can activate tendencies such as
“deal seeking” and/or strong responses to perceived unfairness
3. This can lead to behavior that is objectively irrational
Odd Endings
Perceptions of Odd Endings
• Odd pricing is a tactic in which firms use prices ending just
under a round number
– e.g., $299, 79¢, $2.97, $34.95

• Most common in North America, and done for two reasons:

1. Perception: Although buyers “know” that a price of $299 is essentially $300,
they may be influenced subconsciously by the perception that it is less

2. Recall: Buyers may remember the price as “two hundred and something”
for the product, despite the fact it was essentially $300
Perceptions of Odd Endings
• Does it work? Consider these actual U.S. sales data for margarine:

Price /lb($) Unit Sales

Parkay
Regular Price .83 2,817
Standard Discount Price .63 8,283
Odd-Ending Discount Price .59 14,567
Imperial
Regular Price .89 5,521
Standard Discount Price .71 9,120
Odd-Ending Discount Price .69 17,814
Perceptions of Odd Endings
• Lessons?
1. In general, odd-ending prices tend to be viewed favorably by
consumers and generate more sales than the small discount
over the even-ending price would suggest
2. However, for products where prestige is important, consumers
may infer quality from price, so it may be best to price products
at even levels (e.g., $10 rather than $9.99)
Reference Prices
Reference Prices
• A Reference Price is a price that buyers use as a standard
of comparison to assess the attractiveness of an offered
price for a product or service
• The reference price may be…
– A price in the buyer’s memory
(internal reference price)

– A price derived from information in the marketplace

(external reference price)
External Reference Prices
• Provided explicitly by the marketer…
– “Manufacturer’s Suggested Retail Price” (MSRP)
– “Regular Price”
– “Compare At” price

• Determined by the consumer…

– Price of an alternative product
– Average of all prices for the category / similar items
External Reference Prices
• By influencing the reference prices consumers form,
marketers can influence choice…

ANKER AK-A3145011 AUKEY SK-M12

$59 $49

CHOOSE
THIS
External Reference Prices
• By influencing the reference prices consumers form,
marketers can influence choice…

ANKER AK-A3145011 AUKEY SK-M12

$79 $49
$59

CHOOSE
THIS
External Reference Prices
• By influencing the reference prices consumers form,
marketers can influence choice…

ANKER AK-A3145011 AUKEY SK-M12 VTIN BH172AB

$59 $49 $44

SEEMS SEEMS SEEMS

EXPENSIVE AVERAGE AVERAGE
External Reference Prices
• By influencing the reference prices consumers form,
marketers can influence choice…

ANKER AK-A3145011 AUKEY SK-M12 VTIN BH272AB

$59 $49 $60

SEEMS SEEMS SEEMS

AVERAGE CHEAP AVERAGE
Reference Prices
• Lessons?
1. Reference prices matter; consumers will invariably be thinking
about the price of your product relative to some reference point
2. You can influence a consumer’s reference price…
 Include a comparator that can serve as a reference
 Consider the context in which your price is being evaluated
Willingness to Pay
Willingness to Pay
• From the firm’s perspective, the optimal price equals the
maximum amount the consumer would be willing to pay
• But this changes with the situation – and some firms use
dynamic pricing to take advantage of this…
Willingness to Pay: Coca-Cola’s Big Miscalculation
Coca-Cola is a product whose utility varies from moment to moment.
In a final summer championship, when people meet in a stadium to
enjoy themselves, the utility of a chilled Coca-Cola is very high.
So it is fair it should be more expensive. The machine will simply
make this process automatic.
— Douglas Ivester, Chairman & CEO, Coca-Cola (1997-2000)
Willingness to Pay
• Willingness to pay (WTP) can be influenced by perceptions of
(un)fairness
• Research has also shown that people can be remarkably
inconsistent in the value they assign to things…
Willingness to Pay
For a holiday, you hop in a car and head to Florida. On the second day of your visit, you
are lying on the beach and it’s hot...real hot. For the last hour you have been thinking
about how much you would enjoy a cold drink. A companion gets up to make a phone call
and offers to bring you back a cold bottle of your favorite brand of beer. The only nearby
place where beer is sold is a rundown grocery
fancy resort store. Your companion asks you the
hotel.
maximum price you are willing to pay.

Maximum price quoted…

(a) run down grocery store $ 1.50
(b) fancy resort hotel $ 2.65
Source: Thaler, Marketing Science - 1985
Willingness to Pay
• Lessons?
1. Never assume the maximum a consumer is willing to pay is
fixed; in some contexts, it may be higher, and in some contexts
lower – be sure to account for context when pricing your product
2. Be mindful of whether the price you are charging
(and your basis for charging it) is seen as fair by consumers –
perceptions of unfairness can generate serious backlash
Endowment Effect
Endowment Effect
SCENARIO
Bob has never been willing to pay more than $35 for a bottle of wine.
10 years ago, he purchased a case of wine for about $20 a bottle.
The wine merchant has just offered to buy the wine back for $100 a bottle.

What does Bob do?

Endowment Effect
Did you notice?
• In effect, the scenario asks Bob whether he would prefer
$100 or a $100 bottle of wine
– Since Bob has trouble paying more than $35 for a bottle of wine,
he should sell his bottles
– But… most people in this situation keep the wine
Willingness to Pay
• Lesson?
1. Firms may be able to extract higher prices by decoupling
acquisition from payment
 Get consumers to feel like they own something,
and they may pay more to avoid giving it up
Framing Effects
Framing Effects
• Mountain Equipment Co-op incurs higher costs for credit card
customers, which it wants to recoup
• Assume that the cost to the consumer (net of discount / surcharge)
is the same. How should they advertise the policy?
Our Credit Card Policy… Our Credit Card Policy…
Credit card transactions cost MEC Credit card transactions cost MEC
more to process than cash. As a more to process than cash. As a
result, customers who choose to use result, customers who choose to use
their credit card will be charged an cash will receive a discount on their
additional fee equivalent to the cost purchase equivalent to the cost of
of using a credit card. using a credit card.
Framing Effects
• Behavioural science tells us to position it as a discount for
people who opt to pay with cash
• Cash discount is seen as a gain
• Credit surcharge is viewed as a loss
– People who want to use their credit card will be more willing to
give up the cash discount than accept a credit card surcharge
Framing Effects
• Behavioral economists have devoted a great deal of effort to
understand how people experience losses and gains
• Based on large-sample observation of actual human behavior,
Daniel Kahneman and Amos Tversky developed something they
called the value function
• A key insight in this model is that “losses loom larger than gains”
– that is, the pain caused by a loss is more intensely felt than
the pleasure caused by a gain of similar magnitude
 Perceived Value (+)
Pleasure
The Value Function: “Losses Loom Larger than Gains”

Pleasure from
gain
$ Amount $ Amount
of Loss of Gain

Pain from
loss
The value function is part of a broader
line of work known as Prospect
Theory, which won the 2002 Nobel
Prize for economics for its creators,
Daniel Kahneman and Amos Tversky

Pain
Perceived Value (–)
Framing Effects
• Another characteristic of this “value function” is that it flattens as
you move further from the reference point…
 Perceived Value (+)
Pleasure
The ValueSmall
Function: Curve Flattens
losses create a
disproportionate sting (i.e., more
as You Move Farther from Origin
pain than their size suggests),
because the value function is
particularly steep near the
origin (i.e., zero point)

$ Amount $ Amount
of Loss of Gain

Bundling small losses into

a single larger loss lessens
the overall sting of the loss

Pain
Perceived Value (–)
 Perceived Value (+)
Pleasure
Conversely, small gains provide
The Value Function: Bundle Losses
more pleasure than their size
and Unbundle Gains
might suggest, so it makes sense
to unbundle them and let each be
experienced separately

$ Amount $ Amount
of Loss of Gain

The value function has been found

to flatten more quickly for gains
than for losses, reflecting the fact
that “losses loom larger than gains”

Pain
Perceived Value (–)
Framing Effects
• Lessons?
1. Best to frame offers as gains rather than losses

2. Take advantage of the value function…

– Bundle losses so they are seen as one large loss
rather than a series of small losses
 e.g., one large price hike, rather than a series of small ones

– Unbundle gains so that each can be enjoyed separately

 e.g., highlight each individual discount and promotional item
End of Lecture