Price Determination

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Chapter 12
Price Determination
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Chapter Goals

• Meaning of price
• Concept of price and value
• Pricing objectives
• Factors influencing price
• Costs of producing and marketing a product
• Approaches to determine price
• Break-even analysis
• Strategies related

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Meaning of Price
PRICE Amount of money and/or other items with
utility needed to acquire a product
Dues
Salary
Wage
Fare
Tuition
Interest
Rent
Commission
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Importance of Price
Economy
Firm
Customer
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Pricing Objectives Profit-Oriented
Achieve a Target Return
Maximize Profits
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Pricing Objectives Sales-Oriented
Increase Sales Volume
Maintain or Increase Market Share
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Pricing Objectives Status Quo
Meet Competition
Stabilize Prices
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Factors Influencing Price
Estimated Demand
Expected price
Demand curve
Price elasticity
Competitive Reactions
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Price and Marketing Mix
Price
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Costs for an Individual Firm
Inverse Demand
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Cost-Plus Pricing
Setting the price of one unit of a product
equal to the total cost of the unit plus the
desired profit on the unit
SELLING PRICE
Total Cost Profit
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Kings Kastles
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Markup Pricing
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Break-Even Analysis
BREAK-EVEN POINT The quantity of output at
which total revenue equals total costs assuming
a certain selling price
B E P
Total revenue Total costs
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Computation of Break-Even Point
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Break-Even Chart
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Pricing and Competition
Perfect Competition
Above Competition
Below Competition
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Value
Benefits
Value
__________________
Price Incurred costs
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The FOUR Generic Competitive Strategies
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A Low-Cost Leadership Strategy
Objective

• Open up a sustainable cost advantage over rivals,
  using lower-cost edge as a basis either to
• Under-price rivals and reap market share gains
  OR
• Earn higher profit margin selling at going price

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Low-Cost Leadership
Keys to Success

• Make achievement of low-cost relative to rivals
  the THEME of firms business strategy
• Find ways to drive costs out of business
  year-after-year

Low-cost leadership means low OVERALL costs, not
just low manufacturing or production costs!
Low-cost leadership means low OVERALL costs, not
just low manufacturing or production costs!
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Approaches to Securinga Cost Advantage
Approach 1

• Do a better job than rivals of performing value
  chain activities efficiently and cost effectively

Approach 2
Revamp value chain to bypass some cost-producing
activities
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Approach 1 Controlling the Cost Drivers

• Capture scale economies avoid scale diseconomies
• Capture learning and experience curve effects
• Manage costs of key resource inputs
• Consider linkages with other activities in value
  chain
• Find sharing opportunities with other business
  units
• Compare vertical integration vs. outsourcing
• Assess first-mover advantages vs. disadvantages
• Control percentage of capacity utilization
• Make prudent strategic choices related to
  operations

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Approach 2 Revamping the Value Chain

• Simplify product design
• Offer basic, no-frills product/service
• Shift to a simpler, less capital-intensive, or
  more streamlined technological process
• Find ways to bypass use of high-cost raw
  materials
• Use direct-to-end user sales/marketing approaches
• Relocate facilities closer to suppliers or
  customers
• Reengineer core business processes---be creative
  in finding ways to eliminate value chain
  activities
• Use PC technology to delete works steps, modify
  processes, cut out cost-producing activities

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Characteristics of aLow-Cost Provider

• Cost conscious corporate culture
• Employee participation in cost-control efforts
• Ongoing efforts to benchmark costs
• Intensive scrutiny of budget requests
• Programs promoting continuous cost improvement

• Low-cost producers champion FRUGALITY while
• aggressively
• INVESTING in cost-saving improvements!

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The Competitive Strengths of Low-Cost
Leadership

• Better positioned than RIVAL COMPETITORS to
  compete offensively on basis of price
• Low-cost provides some protection from bargaining
  leverage of powerful BUYERS
• Low-cost provides some protection from bargaining
  leverage of powerful SUPPLIERS
• Low-cost providers pricing power acts as a
  significant barrier for POTENTIAL ENTRANTS
• Low cost puts a company in position to use low
  price as a defense against SUBSTITUTES

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A Low-Cost Strategy Works Best When

• Price competition is vigorous
• Product is standardized or readily available
  from many suppliers
• There are few ways to achieve differentiation
  that have value
• Most buyers use product in same ways
• Buyers incur low switching costs
• Buyers are large and have significant bargaining
  power

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Pitfalls of Low-Cost Strategies

• Being overly aggressive in cutting price (revenue
  erosion of lower price is not offset by gains in
  sales volume--profits go down,not up)
• Low cost methods are easily imitated by rivals
• Becoming too fixated on reducing costsand
  ignoring
• Buyer interest in additional features
• Declining buyer sensitivity to price
• Changes in how the product is used
• Technological breakthroughs open up cost
  reductions for rivals

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Differentiation Strategies
Objective

• Incorporate differentiating features that cause
  buyers to prefer firms product or service over
  the brands of rivals
• Find ways to differentiate that CREATE VALUE for
  buyers and that are NOT EASILY MATCHED or
  CHEAPLY COPIED by rivals
• Not spending more to achieve differentiation than
  the price premium that can be charged

Keys to Success
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The Appeal of Differentiation Strategies

• A powerful competitive approach when uniqueness
  can be achieved in ways that
• Buyers perceive as valuable
• Rivals find hard to match or copy
• Can be incorporated at a cost well below the
  price premium that buyers will pay

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The Benefits of Successful Differentiation

• A product / service with unique and appealing
  attributes allows a firm to
• Command a premium price and/or
• Increase unit sales and/or
• Build brand loyalty Competitive Advantage

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Types of Differentiation Themes

• Unique taste -- Dr. Pepper
• Special features -- America Online
• Superior service -- FedEx, Ritz-Carlton
• Spare parts availability -- Caterpillar
• Engineering design and performance -- Mercedes
• Prestige -- Rolex
• Quality manufacture -- Honda , Toyota
• Technological leadership -- 3M Corporation, Intel
• Top-of-the-line image -- Ralph Lauren, Chanel

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Sustaining Differentiation The Key to
Competitive Advantage

• Most appealing approaches to differentiation
• Those hardest for rivals to match or imitate
• Those buyers will find most appealing
• Best choices for gaining a longer-lasting, more
  profitable competitive edge
• New product innovation
• Technical superiority
• Product quality and reliability
• Comprehensive customer service

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Where to Find Differentiation Opportunities
in the Value Chain

• Purchasing and procurement activities
• Product RD activities
• Production RD technology-related activities
• Manufacturing activities
• Outbound logistics and distribution activities
• Marketing, sales, and customer service activities

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Signaling Value as Well as Delivering Value

• Buyers seldom pay for value that is not perceived
• Signals of value may be as important as actual
  value when
• Nature of differentiation is hard to quantify
• Buyers are making first-time purchases
• Repurchase is infrequent
• Buyers are unsophisticated

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The Competitive Strengths of a
Differentiation Strategy

• Buyers develop loyalty to brand they like
  best--can beat RIVAL COMPETITORS in the
  marketplace
• Mitigates bargaining power of large BUYERS since
  other products are less attractive
• Differentiation puts a seller in better position
  to withstand efforts of SUPPLIERS to raise prices
• Buyer loyalty acts as a barrier to POTENTIAL
  ENTRANTS
• Differentiation puts a seller in better position
  to fend off threats of SUBSTITUTES not having
  comparable features

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A Differentiation Strategy Works Best When

• There are many ways to differentiate a product
  that have value and please customers
• Buyer needs and uses are diverse
• Few rivals are following a similar type of
  differentiation approach
• Technological change is fast-paced and
  competition is focused on evolving product
  features

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What Can Make aDifferentiation Strategy Fail

• Trying to differentiate on a feature buyers do
  not perceive as lowering their cost or enhancing
  their well-being
• Over-differentiating such that product features
  exceed buyers needs
• Charging a price premium that buyers perceive is
  too high
• Failing to signal value
• Not understanding what buyers want or prefer and
  differentiating on the wrong things

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Competitive Strategy Principle
A low-cost producer strategy can defeat a
differentiation strategy when buyers are
satisfied with a standard product and do not
see extra attributes as worth paying for!
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The Strategy Clock
Note The strategy clock is adapted from the work
of Cliff Bowman (see D. Faulkner and C. Bowman,
The Essence of Competitive Strategy, Prentice
Hall, 1995.) However, Bowman uses the dimenstion
Perceived Use Value.
Exhibit 5.2a
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The Strategy Clock
Exhibit 5.2b
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No Frills Strategy
Low price Low perceived product/service
benefits Focus on price-sensitive market segment

• Commodity-like products or services
• Price-sensitive customers
• High buyer power and/ or low switching costs
• Small number of providers with similar market
  shares

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Low Price Strategy
Lower price than competitors Maintain similar
product/service benefits Public sector year on
year efficiency gains

• Pitfalls of low price strategy
• Margin reduction (competitor reaction)
• Inability to reinvest leading to loss of
  perceived benefit of product
• Need a low cost base
• Low cost itself not a basis for advantage
• Low cost achieved in ways that competitors cannot
  match to give sustainable advantage

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Differentiation Strategies
Offering benefits different from
competitors Widely valued by buyers Better
products/services at same or higher price Public
sector - centre of excellence

• Success depends on
• Identification of strategic customers and knowing
  what they value
• Knowing the competitors
• Narrow competitor base focused differentiation
• Wide competitor base address bases of
  differentiation valued by customers

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Hybrid Strategy
Simultaneously achieving differentiation and a
price lower than competitors

• Achieve greater volumes
• Clarity about activities on which differentiation
  can be built (core competences)
• Reduce costs on other activities
• Entry strategy in market with established
  competitors

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Focused Differentiation
High perceived product/service benefits to
selected market segment (niche) Premium
products, heavily branded

• Choice to be made between focused differentiation
  and broad differentiation if growth required
• Difficult when the focus strategy is only part of
  an organisations overall strategy
• Possible conflict with stakeholder expectations
• New ventures start off focused, but need to grow
• Market situation may change, reducing differences
  between segments

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Failure Strategies
Do not provide perceived value-for-money in terms
of product features, price or both

• Increase price without increasing product/service
  benefit
• Reduce benefits whilst maintaining price

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Earnings in cost and differentiating
strategies..

• ROI OPERATING INCOME / INVESTMENT
• ROI OI/I ROI OI/ SALES SALES/I

TURNOVER
MARGIN
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Price Determination Process
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Competition
Low Price
Price
Value Pricing
Stable Price Emphasize other parts of marketing
mix
Non- Price
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Market-Entry Strategies
Market-Skimming Pricing
Set a relatively high price. See when this
strategy is Possible page 361
Market-Penetration Pricing
Low initial price See when this strategy
is Possible page 361
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Discounts and Allowances
Quantity Discounts
Trade Discounts
Reductions based on buyer performing marketing
functions
Cash Discounts
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Pricing Strategies
One- price
Flexible- price
High-Low pricing
Everyday low price
See each one explained on pages 369 370