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Chapter 11 PRICING STRATEGIES MARKETING STARTER: CHAPTER 11 Panera Bread Company: Value Isn’t Just About Low Prices

Synopsis At Panera Bread Company, value means a lot more than just low prices. It means wholesome food and fresh-baked bread, served in a warm and inviting environment, even if you have to pay a little more for it. In the restaurant business these days, value typically means one thing— cheap. Today’s casual restaurants are offering a seemingly endless hodgepodge of value meals, dollar items, budget sandwiches, and rapid-fire promotional deals that scream ―value, value, value.‖ But Panera understands that even when finances are tight, low prices often aren’t the best value. Why is Panera Bread so successful? Unlike so many competitors in the post-Great Recession era, Panera is about the value you get for what you pay, and what you get is a full-value dining experience. At Panera, it all starts with the food, which centers around fresh-baked bread. Fresh bagels, pastries, egg soufflés, soups, salads, sandwiches and paninis, and coffee drinks and smoothies give customers full meal options at any time of day. Perhaps even more important is the Panera experience—one so inviting that people don’t want to leave. Even during the Great Recession, rather than cutting back on value and lowering prices in difficult times, Panera boosted quality and value while competitors cut back. Freshness has remained a driving force. Adding value and charging accordingly has paid off handsomely for Panera, through bad economic times and good.

Discussion Objective A focused 10-minute discussion of the chapter-opening Panera Bread Company story will show students that a proper price/value equation will ring true with customers and produce strong sales and profits. In the Panera context, ―proper‖ means fresh, high-quality breads, soups, salads, and beverages – all offered in cushy, upscale surroundings that invite long customer stays. As a result, Panera Bread Company’s customers can’t stay away from the place. The discussion will also highlight the concept that companies can add value and charge accordingly. This is the key element in Panera’s price/value strategy.

Starting the Discussion Start by asking what students know about Panera Bread Company, and how their experiences fit with the opening vignette. Next, give the students a feel for Panera Bread Company, its unique price/value equation, and how customers feel about the place by visiting their website at www.panerabread.com. You can also enter the company name on www.YouTube.com and check out several of their videos. Here, you will even find recipes for soups, breads, and more that Panera shares with anyone interested. Ask the students how this tactic underscores the unique Panera brand, and how it can further build even more consumer appeal. Once you’ve captured the essence of the Panera experience, you can explore the model behind the value proposition.

Discussion Questions 1.

What is Panera Bread Company all about? How does it create its own niche in the crowded restaurant marketplace? (After initial responses, view several videos on www.YouTube.com Discuss the value Panera offers and what it charges to draw out the store’s value equation: providing more value than competitors and charging accordingly. Panera Bread Company’s unique price/value equation has led to a fanatical following that is really more ―Food Network‖ than it is ―fast food.‖ People go out of their way to

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visit a store. Also discuss Panera’s warm, comfortable surroundings. Customers linger, gather, and spend even more. It is almost as though Panera rents the space to them, and that food is the price of admission.) 2.

How can Panera Bread Company charge considerably more for its food and drinks than its competitors and still outsell them – even in a recessionary economy? (Panera adheres to a simple value proposition: offer more value and charge accordingly; the customers will come. Panera understands that even when finances are tight, low prices often aren’t the best value. In the words of founder Ronald Shaich, ―Give people something of value and they’ll happily pay for it.‖ Perhaps even more important is the Panera experience— one so inviting that people won’t want to leave. And as always, freshness remains a driving force. )

3.

How does the Panera Bread Company story relate to the concepts presented later in Chapter 11? (The Panera story provides a nice bridge between Chapter 10 [Pricing Strategies] and Chapter 11 [Additional Pricing Considerations]. Once again, it demonstrates the importance of price in creating value for customers and illustrates the many factors that affect pricing decisions. But it also suggests that price, on its own, is only one part of a broader price/value equation.)

CHAPTER OVERVIEW Use Power Point Slide 11-1 Here In this chapter, we’ll explore pricing considerations including: new product pricing, product mix pricing, price adjustments, and initiating and reacting to prices changes. We close the chapter with a discussion of public policy and pricing. A company does not set a single price, but rather a pricing structure that covers different items in its line. This pricing structure changes over time as products move through their life cycles. The company adjusts its prices to reflect changes in costs and demand and to account for variations in buyers and situations. As the competitive environment changes, the company considers when to initiate price changes and when to respond to them. This chapter examines additional pricing approaches used in special pricing situations and adjusting prices to meet changing conditions. The chapter covers new-product pricing for products in the introductory stage of the PLC, product mix pricing for related products in the product mix, price-adjustment tactics that account for customer differences and changing situations, and strategies for initiating and responding to price changes.

CHAPTER OBJECTIVES Use Power Point Slide 11-2 Here 1. Describe the major strategies for pricing imitative and new products. 2. Explain how companies find a set of prices that maximize the profits from the total product mix. 3. Discuss how companies adjust their prices to take into account different types of customers and situations. 4. Discuss the key issues related to initiating and responding to price changes. 5. Overview the social and legal issues that affect pricing decisions.

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CHAPTER OUTLINE p. 312

INTRODUCTION At Panera Bread Company, value means a lot more than just p. 313 low prices. It means wholesome food and fresh-baked Ad: Panera Bread bread, served in a warm and inviting environment, even if you have to pay a little more for it. In the restaurant business these days, value typically means one thing— cheap. But Panera understands that even when finances are tight, low prices often aren’t the best value. Unlike so many competitors in the post-Great Recession era, Panera is about the value you get for what you pay, and what you get is a full-value dining experience. At Panera, it is all about the food. But perhaps even more important is the Panera experience—one so inviting that people don’t want to leave.

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Even during the Great Recession, rather than cutting back on value and lowering prices in difficult times, Panera boosted quality and value while competitors cut back. This strategy has paid off handsomely for Panera.  Opening Vignette Questions 1. Explain Panera’s pricing strategy in your own words. What do they mean by the term ―price‖? 2. How is Panera distinguishing itself from other ―value-oriented‖ restaurants in the wake of the Great Recession? 3. Analyze the statement, ―Give people something of value, and they’ll gladly pay for it.‖ How does it apply to Panera? Chapter Objective 1 NEW-PRODUCT PRICING STRATEGIES Companies bringing out a new product face the challenge of setting prices for the first time. They can choose between two broad strategies.

p. 314 PPT 11-3

Market-Skimming Pricing Many companies that invent new products set high initial p. 314-315 prices to ―skim‖ revenues layer-by-layer from the market. Key Terms: MarketThis is called market-skimming pricing. Skimming Pricing, Market-Penetration Market skimming makes sense only under certain Pricing conditions.

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1. The product’s quality and image must support its higher price, and enough buyers must want the product at that price. 2. The costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. 3. Competitors should not be able to enter the market easily and undercut the high price. Market-Penetration Pricing p. 315 PPT 11-4

Rather than setting a high price to skim off small but profitable market segments, some companies use market- p. 315 penetration pricing. They set a low initial price in order to Photo: IKEA penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. Several conditions must be met for this low-price strategy to work. 1. The market must be highly price sensitive so that a low price produces more market growth. 2. Production and distribution costs must fall as sales volume increases. 3. The low price must help keep out the competition, and the penetration pricer must maintain its lowprice position—otherwise, the price advantage may be only temporary.  Assignments, Resources Use Discussion Question1 here Use Critical Thinking Exercise 1 here Use Marketing Technology here Use Additional Project 1 here Use Individual Assignment 1 here Use Think-Pair-Share 1 here Use Outside Example 1 here Use Web Resources 1, 2, and 3 here  Troubleshooting Tip The students should not have any trouble with the material on market-skimming or market-penetration pricing if the material was covered in the product life-cycle chapter. Reinforcement here, however, is useful (especially if time did not permit earlier coverage). The techniques are best discussed with examples. A useful method is to divide the students Copyright©2014 Pearson Education

into small groups and give them two or three products and have them (one group takes market skimming and another takes market penetration) create separate strategies and then debate between the groups. Have each group explain why their method was superior. p. 315 PPT 11-5

PRODUCT MIX PRICING STRATEGIES

p. 316

Product Line Pricing

PPT 11-6

Chapter Objective 2

p. 316 Key Term: Product Companies usually develop product lines rather than single Line Pricing products. p. 316 In product line pricing, management must decide on the Table 11.1: Product price steps to set between the various products in a line. Mix Pricing The price steps should take into account cost differences between the products in the line. More importantly, they should account for differences in customer perceptions of the value of different features. The seller’s task is to establish perceived quality differences that support the price differences. p. 316 Key Terms: Optional Product Many companies use optional product pricing—offering Pricing, Captive to sell optional or accessory products along with their main Product Pricing, product.

p. 316

Optional Product Pricing

p. 316

Pricing these options is a sticky problem. The company has to decide which items to include in the base price and which to offer as options. p. 316 Ad: Mr. Clean Captive Product Pricing

PPT 11-7

Companies that make products that must be used along with a main product are using captive product pricing. Producers of the main products often price them low and set high markups on the supplies. In the case of services, this strategy is called two-part pricing. The price of the service is broken into a fixed fee plus a variable usage rate. Copyright©2014 Pearson Education

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By-Product Pricing

p. 317 Photo: By-Product Using by-product pricing, a company will seek a market Pricing for by-products and should accept any price that covers more than the cost of storing and delivering them. p. 317 Key Term: ByBy-products can even turn out to be profitable. Product Pricing

p. 317 PPT 11-8

Product Bundle Pricing Using product bundle pricing, sellers often combine several of their products and offer the bundle at a reduced price. Price bundling can promote the sales of products consumers might not otherwise buy, but the combined price must be low enough to get them to buy the bundle.  Assignments, Resources Use Discussion Question 2 here Use Additional Projects 2, 3, and 4 here Use Individual Assignment 2 here Use Web Resource 4 here  Troubleshooting Tip The next barrier the students may encounter is in dealing with the various product mix pricing strategies (see Table 11.1). Through in-class discussion, have students construct examples for each of the categories in this subsection of the chapter. Once students understand the definitional nature of the strategies, expand the discussion to when the strategies are best used. The chapter supplies information that will aid this explanation process.

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PRICE ADJUSTMENT STRATEGIES

PPT 11-9

Companies usually adjust their basic prices to account for various customer differences and changing situations.

Chapter Objective 3

p. 318 The seven price-adjustment strategies are summarized in Table 11.2: PriceTable 11.2. Adjustment Strategies Copyright©2014 Pearson Education

p. 318

Discount and Allowance Pricing Most companies adjust their basic price to reward customers for certain responses, such as early payment of bills, volume purchases, and off-season buying.

PPT 11-10 The many forms of discounts include a cash discount, a price reduction to buyers who pay their bills promptly. A typical example is ―2/10, net 30,‖ which means that although payment is due within 30 days, the buyer can deduct 2 percent if the bill is paid within 10 days.

p. 318 Key Terms: Discount, Allowance, Segmented Pricing

A quantity discount is a price reduction to buyers who buy large volumes. A functional discount (trade discount) is offered by the seller to trade-channel members who perform certain functions, such as selling, storing, and record keeping. A seasonal discount is a price reduction to buyers who buy merchandise or services out of season. Allowances are another type of reduction from list price. Trade-in allowances are price reductions given for turning in an old item when buying a new one. Promotional allowances are payments or price reductions to reward dealers for participating in advertising and sales support programs. Segmented Pricing p. 318 Companies will often adjust their basic prices to allow for differences in customers, products, and locations. PPT 11-11 In segmented pricing, the company sells a product or service at two or more prices, even though the difference in p. 318 price is not based on differences in costs. Table 11.2 Price Adjustments PPT 11-12 Under customer-segment pricing, different customers pay different prices for the same product or service. Under product-form pricing, different versions of the product are priced differently but not according to differences in their costs. Copyright©2014 Pearson Education

Under location pricing, a company charges different prices p. 319 for different locations, even though the cost of offering each Photo: Airline location is the same. seating Using time-based pricing, a firm varies its prices by the season, the month, the day, and even the hour. p. 319 For segmented pricing to be an effective strategy, certain PPT 11-13 conditions must exist: • • •

The market must be segmentable, and the segments must show different degrees of demand. The costs of segmenting and watching the market cannot exceed the extra revenue obtained from the price difference. The segmented pricing must be legal.

 Assignments, Resources Use Real Marketing 11.1 here Use Marketing Ethics here Use Small Group Assignment 1 here  Troubleshooting Tip The material from the price adjustment strategies and price changes sections can be difficult for the student who has not carefully read the material. The best way to handle this is to give a brief vocabulary quiz at the beginning of the material and then discuss the material that has not been learned or has been misapplied. Time constraints usually prevent detailed analysis of this material, but it can be integrated into future examples (when dealing with broader mix situations) and can be reinforced in that way. The only way to really learn pricing vocabulary is to use it in a daily manner. Have students practice this. The strategic options can also be better understood when related to actual material. As students read contemporary material from business magazines, have them look for these techniques. BusinessWeek, Fortune, or Newsweek make good sources for examples. p. 319

Psychological Pricing p. 319 Price says something about the product. For example, many Key Term: consumers use price to judge quality. Psychological Copyright©2014 Pearson Education

Pricing , Reference PPT 11-14 In using psychological pricing, sellers consider the Prices psychology of prices, not simply the economics. Another aspect of psychological pricing is reference p. 321 prices—prices that buyers carry in their minds and refer to Photo: when looking at a given product. Psychological Pricing  The reference price might be formed by noting current prices, remembering past prices, or assessing the buying situation.  Sellers can influence or use these consumers’ reference prices when setting price. For most purchases, consumers don’t have all the skill or information they need to figure out whether they are paying a good price. They may rely on certain cues that signal p. 320 Photo: Pricing cues whether a price is high or low. Even small differences in price can signal product differences. p. 321

Promotional Pricing With promotional pricing, companies will temporarily p. 321 price their products below list price and sometimes even Key Term: Promotional Pricing below cost to create buying excitement and urgency. Promotional pricing takes several forms.

PPT 11-15

p. 322  The seller may simply offer discounts from normal Photo: Promotional Pricing prices to increase sales and reduce inventories.  Sellers will also use special-event pricing in certain seasons to draw more customers.  Manufacturers sometimes offer cash rebates to consumers who buy the product from dealers within a specified time.  Some manufacturers offer low-interest financing, longer warranties, or free maintenance to reduce the consumer’s ―price.‖

PPT 11-16 Promotional pricing can have adverse effects.  Used too frequently and copied by competitors, price promotions can create ―deal-prone‖ customers who wait until brands go on sale before buying Copyright©2014 Pearson Education

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them.  Constantly reduced prices can erode a brand’s value in the eyes of customers.  Marketers sometimes use price promotions as a quick fix instead of sweating through the difficult process of developing effective longer-term strategies for building their brands. Promotional pricing can be an effective means of generating sales in certain circumstances, but it can be damaging for other companies or if taken as a steady diet.  Assignments, Resources Use Discussion Question 3 here Use Think-Pair-Share 2 here Use Web Resource 5 here p. 322 Geographical Pricing PPT 11-17 A company also must decide how to price its products for customers located in different parts of the country or world. PPT 11-18

PPT 11-19

PPT 11-20

1. FOB-origin pricing is a practice that means the goods are placed free on board (hence, FOB) a carrier. At that point the title and responsibility pass to the customer, who pays the freight from the factory to the destination. 2. Uniform-delivered pricing is the opposite of FOB pricing. Here, the company charges the same price plus freight to all customers, regardless of their location. The freight charge is set at the average freight cost. 3. Zone pricing falls between FOB-origin pricing and uniform-delivered pricing. The company sets up two or more zones. All customers within a given zone pay a single total price; the more distant the zone, the higher the price. 4. Using basing-point pricing, the seller selects a given city as a ―basing point‖ and charges all customers the freight cost from that city to the customer location, regardless of the city from which the goods are actually shipped. 5. The seller who is anxious to do business with a certain customer or geographical area might use freight-absorption pricing. Using this strategy, the seller absorbs all or part of the actual freight charges in order to get the desired business. Copyright©2014 Pearson Education

p. 322 Key Terms: Geographical Pricing, FOBOrigin Pricing, Uniform-Delivered Pricing, Zone Pricing, BasingPoint Pricing

p. 323 Key Terms: Freight-Absorption Pricing, Dynamic Pricing

p. 323 Dynamic and Internet Pricing PPT 11-21 Dynamic pricing offers many advantages for marketers. p. 323 Internet sellers can mine their databases to gauge a specific Photo: eBay shopper’s desires, measure his or her means, and instantaneously tailor products to fit that shopper’s behavior, and price products accordingly. Buyers also benefit from the Web and dynamic pricing. p. 324 International Pricing PPT 11-22 Companies that market their products internationally must p. 324 decide what prices to charge in the different countries in Photo: McDonald’s which they operate. p. 326 International In some cases, a company can set a uniform worldwide Pricing price. However, most companies adjust their prices to reflect local market conditions and cost considerations. The price that a company should charge in a specific country depends on many factors, including economic conditions, competitive situations, laws and regulations, and development of the wholesaling and retailing system. Consumer perceptions and preferences also may vary from country to country, calling for different prices. Or the company may have different marketing objectives in various world markets that require changes in pricing strategy. Costs play an important role in setting international prices. Travelers abroad are often surprised to find that goods that are relatively inexpensive at home may carry outrageously higher price tags in other countries. In some cases, such price escalation may result from differences in selling strategies or market conditions. In most instances, however, it is simply a result of the higher costs of selling in another country—the additional costs of product modifications, shipping and insurance, import tariffs and taxes, exchange rate fluctuations, and physical distribution.

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 Assignments, Resources Use Discussion Questions 4 and 5 here Use Critical Thinking Exercise 2 here Use Think-Pair-Share 3 and 4 here Use Web Resource 6 here p. 325

PRICE CHANGES

Chapter Objective 4

Companies often face situations in which they must initiate price changes or respond to price changes by competitors. p. 325 Initiating Price Changes PPT 11-23 Initiating Price Cuts p. 325 Several situations may lead a firm to consider cutting its Photo: Mobil price.   

One such circumstance is excess capacity. Another situation leading to price changes is falling demand in the face of strong price competition or a weakened economy. A company may also cut prices in a drive to dominate the market through lower costs. Either the company starts with lower costs than its competitors, or it cuts prices in the hope of gaining market share that will further cut costs through larger volume.

Initiating Price Increases A successful price increase can greatly increase profits.  

A major factor in price increases is cost inflation. Rising costs squeeze profit margins and lead companies to pass cost increases along to customers. Another factor leading to price increases is overdemand. When a company cannot supply all that its customers need, it can raise prices, ration products to customers, or both.

In passing price increases on to customers, the company must avoid being perceived as a price gouger. Price increases should be supported by company communications telling customers why prices are being increased. Copyright©2014 Pearson Education

Whenever possible, the company should consider ways to meet higher costs or demand without raising prices. p. 327 p. 326 Buyer Reactions to Price Changes PPT 11-24 Photo: Tiffany’s Customers do not always interpret price changes in a straightforward way. A brand’s price and image are often closely linked. A price change, especially a drop in price, can adversely affect how consumers view the brand. PPT 11-25 Competitor Reactions to Price Changes Competitors are most likely to react when the number of firms involved is small, when the product is uniform, and when the buyers are well informed about products and prices. The company must guess each competitor’s likely reaction. If all competitors behave alike, this amounts to analyzing PPT 11-26 only a typical competitor. In contrast, if the competitors do not behave alike, then separate analyses are necessary. p. 328 Figure 11.1: p. 328 Assessing and Responding to Price Changes Responding to If a company decides that effective action can and should be Competitor Price taken, it might make any of four responses. Changes PPT 11-27

1. It could reduce its price to match the competitor’s price. The company should try to maintain its quality as it cuts prices. 2. The company might maintain its price but raise the perceived value of its offer. It could improve its communications, stressing the relative quality of its product over that of the lower-price competitor. 3. The company might improve quality and increase price, moving its brand into a higher-price position. The higher quality justifies the higher price that in turn preserves the company’s higher margins. 4. The company might launch a low-price “fighter brand”—adding a lower-price item to the line or p. 329 creating a separate lower-price brand. This is Ad: Starbucks necessary if the particular market segment being lost is price sensitive and will not respond to arguments of higher quality. Copyright©2014 Pearson Education

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 Assignments, Resources Use Video Case here Use Discussion Question 6 here Use Marketing by the Numbers here Use Think-Pair-Share 5 here p. 329

PUBLIC POLICY AND PRICING Price competition is a core element of our free-market economy. In setting prices, companies are not usually free to charge whatever prices they wish. Many federal, state, and even local laws govern the rules of fair play in pricing. The most important pieces of legislation affecting pricing are the Sherman, Clayton, and Robinson-Patman acts, initially adopted to curb the formation of monopolies and to regulate business practices that might unfairly restrain trade.

p. 330 Pricing within Channel Levels PPT 11-28 Federal legislation on price-fixing states that sellers must set p. 329 prices without talking to competitors. Otherwise, price Figure 11.2: Public collusion is suspected. Policy Issues in Pricing Sellers are also prohibited from using predatory pricing— selling below cost with the intention of punishing a p. 330 competitor or gaining higher long-run profits by putting Photo: Amazon competitors out of business. This protects small sellers from larger ones who might sell items below cost temporarily or in a specific locale to drive them out of business. p. 330

Pricing Across Channel Levels

PPT 11-29 The Robinson-Patman Act seeks to prevent unfair price discrimination by ensuring that sellers offer the same price terms to customers at a given level of trade. Price discrimination is allowed if the seller can prove that its costs are different when selling to different retailers. Or the seller can discriminate in its pricing if the seller manufactures different qualities of the same product for different retailers. The seller has to prove that these differences are proportional.

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p. 331 Retail (or resale) price maintenance is prohibited—a PPT 11-30 manufacturer cannot require dealers to charge a specified retail price for its product. Although the seller can propose a manufacturer’s suggested retail price to dealers, it cannot refuse to sell to a dealer who takes independent pricing action, nor can it punish the dealer by shipping late or denying advertising allowances. PPT 11-31 Deceptive pricing occurs when a seller states prices or price savings that mislead consumers or are not actually available to consumers. This might involve bogus reference or comparison prices, as when a retailer sets artificially high ―regular‖ prices then announces ―sale‖ prices close to its previous everyday prices. Deceptive pricing issues include scanner fraud and price confusion. The widespread use of scanner-based computer checkouts has led to increasing complaints of retailers overcharging their customers. Price confusion results when firms employ pricing methods that make it difficult for consumers to understand just what p. 330 price they are really paying. Photo: Deceptive Pricing Concerns Treating customers fairly and making certain that they fully understand prices and pricing terms is an important part of building strong and lasting customer relationships.  Assignments, Resources Use Small Group Assignment 2 here Use Outside Example 1 here

END OF CHAPTER MATERIAL Discussion Questions 1. Compare and contrast market-skimming and market-penetration pricing strategies and discuss the conditions under which each is appropriate. For each strategy, give an example of a recently introduced product that used that pricing strategy. (AACSB: Communication; Reflective Thinking) Answer: Many companies that introduce new products set high initial prices to ―skim‖ revenues layer by layer from the market, a strategy called market-skimming pricing (or price Copyright©2014 Pearson Education

skimming). Market skimming makes sense only under certain conditions. First, the product’s quality and image must support its higher price and enough buyers must want the product at that price. Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price. Rather than setting a high initial price to skim off small but profitable market segments, some companies use market-penetration pricing in which they set a low initial price in order to penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing the company to cut its price even further. Several conditions must be met for this low-price strategy to work. First, the market must be highly price sensitive so that a low price produces more market growth. Second, production and distribution costs must fall as sales volume increases. Finally, the low price must help keep out the competition, and the penetration pricer must maintain its low-price position—otherwise, the price advantage may be only temporary. Students’ examples will vary. The example discussed in the chapter of a product employing a skimming strategy is Apple’s iPhone. Other examples students might discuss are HDTVs when they were first introduced—they were priced at $10,000 or more—or digital cameras. The chapter discusses IKEA in China as an example of penetration pricing. 2. Name and briefly describe the five product mix pricing decisions. (AACSB: Communication) Answer: The product mix pricing situations are: (1) product line pricing, (2) optional-product pricing, (3) captive-product pricing, (4) by-product pricing, and (5) product bundle pricing. In product line pricing, management must decide on the price steps to set between the various products in a line. The price steps should take into account cost differences between the products in the line. More importantly, they should account for differences in customer perceptions of the value of different features. Many companies use optional-product pricing—offering to sell optional or accessory products along with their main product. Pricing these options is a sticky problem, though, as automobile marketers found when advertising the most basic, stripped down version of their cars. Companies that make products that must be used along with a main product are using captive-product pricing. Examples of captive products are razor blade cartridges, video games, and printer cartridges. Producers of the main products (razors, video game consoles, and printers) often price them low and set high markups on the supplies. Companies using captive-product pricing must be careful—consumers trapped into buying expensive supplies may come to resent the brand that ensnared them. In the case of services, captive-product

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pricing is called two-part pricing. The price of the service is broken into a fixed fee plus a variable usage rate. Producing products and services often generates by-products. If the by-products have no value and if getting rid of them is costly, this will affect the pricing of the main product. Using by-product pricing, the company seeks a market for these by-products to help offset the costs of disposing of them and to help make the price of the main product more competitive. The by-products themselves can even turn out to be profitable. Using product bundle pricing, sellers often combine several of their products and offer the bundle at a reduced price. For example, fast-food restaurants bundle a burger, fries, and a soft drink at a ―meal‖ price. 3. Name and describe the various forms of discounts companies use to reward customers. (AACSB: Communication; Reflective Thinking) Answer: One form of discount is a cash discount, a price reduction to buyers who pay their bills promptly. A typical example is ―2/10, net 30,‖ which means that although payment is due within 30 days, the buyer can deduct 2 percent if the bill is paid within 10 days. A quantity discount is a price reduction to buyers who buy large volumes. A seller offers a functional discount (also called a trade discount) to trade-channel members who perform certain functions, such as selling, storing, and record keeping. A seasonal discount is a price reduction to buyers who buy merchandise or services out of season. 4. Compare and contrast the geographic pricing strategies companies use for customers located in different parts of the country or world. Which strategy is best? (AACSB: Communication; Reflective Thinking) Answer: There are five geographical pricing strategies and which one is ―best‖ depends on the market situation:  FOB-origin pricing: this practice means that goods are placed free on board (FOB) a carrier. At that point the title and responsibility pass to the customer, who pays the freight from the factory to the destination. Because each customer picks up its own costs, some feel this is the fairest way to assess freight charges. The disadvantage is that costs are higher for distant customers.  Uniform-delivered pricing: the company charges the same price plus freight to all customers, regardless of their location. The freight charge is set at the average freight costs. This pricing strategy results in a higher charge for closer customers compared to FOB-origin pricing. This strategy is fairly easy to administer and it lets the firm advertise its price nationally.  Zone pricing: falls between FOB-origin pricing and uniform-delivered pricing. The company sets up two or more zones. All customers within a given zone pay a Copyright©2014 Pearson Education

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single total price, the more distant the zone, the higher the price. Customers within a given price zone receive no price advantage from the company, however, close customers within a zone pay part of the freight cost of farther customers within that zone. Basing-point pricing: the seller selects a given city as a ―basing point‖ and charges all customers the freight cost from that city to the customer location, regardless of the city from which the goods are actually shipped. If the basing point is Chicago, for example, but the product is actually shipped from Atlanta, a customer in Atlanta pays the freight cost from Chicago to Atlanta, even though the goods are shipped from Atlanta. This method is less popular today, but some companies set up multiple basing points to create more flexibility and quote charges from the basing-point city nearest to the customer. Freight-absorption pricing: the seller absorbs all or part of the actual freight charges in order to get the desired business under the assumption that if it can get more business, its average costs will fall and more than compensate for its extra freight cost.

5. What is dynamic pricing? Why is it especially prevalent online? Is it legal? (AACSB: Communication) Answer: Dynamic pricing adjusts prices continually to meet the characteristics and needs of individual customers and situations. Dynamic pricing is especially prevalent online, where the Internet seems to be taking us back to a new age of fluid pricing. Such pricing offers many advantages for marketers. For example, Internet sellers can mine their databases to gauge a specific shopper’s desires, measure his or her means, tailor offers to fit that shopper’s behavior, and price products accordingly. And many direct marketers monitor inventories, costs, and demand at any given moment and adjust prices instantly. In the extreme, some companies customize their offers and prices based on the specific characteristics and behaviors of individual customers, mined from online browsing and purchasing histories. Although such dynamic pricing practices might seem legally questionable, they’re not. Dynamic pricing is legal as long as companies do not discriminate based on age, sex, location, or other similar characteristics. 6. Under what circumstances would a company consider cutting its prices? Raising its prices? (AACSB: Communication) Answer: Several situations may lead a firm to consider cutting its prices. One such circumstance is excess capacity. Another is falling demand in the face of strong price competition or a weakened economy. In such cases, the firm may aggressively cut prices to boost sales and market share. But as the airline, fast-food, automobile, and other industries have learned in Copyright©2014 Pearson Education

recent years, cutting prices in an industry loaded with excess capacity may lead to price wars as competitors try to hold onto market share. A company may also cut prices in a drive to dominate the market through lower costs. Either the company starts with lower costs than its competitors, or it cuts prices in the hope of gaining market share that will further cut costs through larger volume. A successful price increase can greatly improve profits. For example, if the company’s profit margin is 3 percent of sales, a 1 percent price increase will boost profits by 33 percent if sales volume is unaffected. A major factor in price increases is cost inflation. Rising costs squeeze profit margins and lead companies to pass cost increases along to customers. Another factor leading to price increases is overdemand: When a company cannot supply all that its customers need, it may raise its prices, ration products to customers, or both.

Critical Thinking Exercises

1. What is the price of a Toyota Prius in the United States? Find the price of a Toyota Prius in five countries and convert that price to U.S. dollars (USD). Are the prices the same or different in other countries? Explain why that might be so. (AACSB: Communication; Use of IT; Reflective Thinking) Answer: Students’ answers will vary based on the countries chosen and the fact that exchange rates vary day by day. For example, Toyota Prius prices range from $26,000 to just over $30,000 in the United States. A Prius is priced at 34,990 Australian dollars in Australia, which is $35,975 (USD). In China, the Prius is priced at 229,800 Yuan, or $36,149. Prices in Brazil are a little higher—100,000 Brazilian Real, which is $49,492. In Singapore, however, a Prius can cost as much as 147,000 Singapore dollars (SGD), which converts to $116,237! The price that a company should charge in a specific country depends on many factors:  economic conditions  competitive situation  laws and regulations  development of the wholesaling and retailing systems  consumer perceptions and preferences  marketing objectives for specific countries  costs 2. One psychological pricing tactic is ―just-below‖ pricing. It is also called ―9-ending‖ pricing because prices usually end in the number 9 (or 99). In a small group, have each member select five different products and visit a store to learn the price of those items. Is there a variation among the items and stores with regard to 9-ending pricing? Why do marketers use this pricing tactic? (AACSB: Communication; Reflective Thinking)

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Answer: Students’ responses will vary depending on the products and types of stores selected. Why do marketers use this tactic? Research reveals that the rightmost digits do not garner as much attention as the leftmost digits, leading researchers to believe that consumers underestimate the price level. While 9-ending prices are effective, 99 cents might be the kingpin. Apple iTune’s 99-cent approach may have saved the music industry and 99 Cent Only stores turned Dave Gold into a millionaire. One study found that when the price of margarine was reduced from 89 cents to 71 cents, sales increased 65 percent, but when price fell to 69 cents, sales skyrocketed more than 200 percent.

Marketing Technology: Talk Less, Pay More Wireless carriers are trying to get customers to pay more for something they do less and less— making phone calls. It seems consumers are doing everything but talking on their mobile phones. Average voice-minute usage has fallen since Apple introduced the iPhone in 2007 and consumers have turned to text and voice-over-Internet calling options such as Skype. But voice billings account for almost 70 percent of what carriers charge mobile phone customers, and they don’t want this cash cow to dry up. As a result, carriers are starting to drop plans that allow subscribers to buy only the minutes they need or want and are replacing them with flat rates covering unlimited calling. Carriers say this would be less complicated for consumers, but the real reason is that they do not want customers trading down to cheaper plans when they realize they can save money by scaling back their voice plans. So carriers are eliminating tiered-pricing voice plans altogether. 1. Compare the prices of two mobile phone carriers such as AT&T and Verizon. What types of pricing strategies are they using? (AACSB: Communication; Reflective Thinking) Answer: Pricing strategies for mobile carriers are complicated. Students might argue that these providers use optional product pricing, which is the pricing of optional or accessory products along with a main product. The main product would be voice minutes and optional products are texting and data usage. Phones are often discounted as part of plans, which is an example of an accessory product. However, it could be argued that captive product pricing is being used as data and text products must be used along with the main voice product. Finally, students might argue that these companies are using product bundle pricing, which is pricing bundles of products sold together. This is especially true with family plans where adding another line only costs $9.99. 2. Visit www.myrateplan.com/wireless_plans/ to compare your mobile phone plan to other carriers’ plans. What tactics do carriers use to keep subscribers from switching? Explain. (AACSB: Communication; Use of IT; Reflective Thinking)

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Answer: Students’ answers will vary. Some students may be added on to their parents’ plans, so switching will be very costly for them. Many carriers require two-year contracts due to discounts given on phones, which create high switching costs.

Marketing Ethics: The Price of a Song Country music stars such as Taylor Swift, Rascal Flatts, and Tim McGraw will be the first artists to be paid every time their songs are played on the radio. In the United States, only songwriters and music publishers receive royalties from radio airplay or when a song is played in a movie, television program, commercial, or even as hold music on telephones. This dates back to a 1917 Supreme Court ruling that composers of copyrighted music are due a royalty every time the music is played or performed through commercial means. But performing artists or recording companies do not receive such royalties. The rationale is that radio play promotes record sales, where the artists earn royalties ranging from 8 to 25 percent of the price of a CD. But thanks to the Internet and music download sites such as iTunes, sales of traditional recorded music have dropped almost 50 percent. In 2011, digital music sales surpassed traditional CD sales. Listeners have also tuned in to Internet sites such as Pandora, Spotify, and Rdio to listen to music. Recording artists did get some relief through the Digital Performance Rights in Sound Recording Act of 1995. The act gave performers their first royalties when their songs are played in a digital format, such as in a Webcast or on satellite radio, where listeners subscribe but cannot select specific songs. Pandora, the online radio company, claims that such royalty payments, equivalent to about 60 percent of revenues, are the reason the company is unprofitable. 1. Research how music royalties work to learn more about the cost and pricing of music. Write a report of what you learned. (AACSB: Communication; Reflective Thinking) Answer: Students can search the Internet to learn how music royalties work. A good source is http://entertainment.howstuffworks.com/music-royalties.htm. It’s actually very complicated with mechanical licenses and royalties, performance rights and royalties, synchronization rights and royalties, and print rights and royalties. Even manufacturers of blank recording media must pay a percentage of sales to the Register of Copyrights to compensate for the lost sales due to copying of purchased recordings. Unlike songwriters and publishers, recording artists and record labels do not receive royalties on public performances; that is, when their music is played on the radio, TV, or other places like restaurants and bars they do not receive compensation. They earn money from the sale of their recordings. Songwriters and publishers earn royalties each time a piece is played because it is based on copyright law. Performers used to beg to get airtime on radio because that was the only promotion for their music. However, things have changed due to the Internet where performers can be discovered on YouTube and do not necessarily need traditional radio to promote their songs. Copyright©2014 Pearson Education

The only royalties artists can earn is when their songs are played in a digital arena, such as the Webcasts or satellite radio, and the listener is a subscriber but does not select the songs to hear. Artists and their backers don’t want their work used for free in other commercial venues, however, and several music labels that represent performers are fighting back and demanding royalties. For example, Big Machine Label Group, a company that represents several big country stars like those listed above, entered a deal with Clear Channel Media & Entertainment, which is the largest U.S. radio broadcaster.

Marketing by the Numbers: Is Netflix Crazy or Savvy? Price increases are always a thorny issue with consumers, and Netflix, the video streaming and DVD-by-mail giant, set off a firestorm by announcing a 60 percent price increase on its most affordable rental plan. Previously, for $9.99 per month, customers were able to rent one DVD at a time plus enjoy unlimited streaming over the Internet. That same service now costs $15.98 per month, a combination of an existing $7.99-a-month streaming-only plan with a new $7.99-amonth DVD-only plan that allows customers to receive one disc at a time via mail. So customers either had to ante up to continue with the same level of service or step down to one of the more limited services priced at $7.99 per month. Most customers switched to the streaming-only option, which reduced variable costs for Netflix due to postage savings. Netflix had 23 million subscribers of the $9.99 per month DVD/streaming hybrid plan prior to the price increase. 1. Refer to Appendix 2, Marketing by the Numbers and calculate the monthly contribution Netflix realizes from a subscriber at the price of $9.99 per month and $15.98 per month, respectively. Assume average variable costs per customer are $3.50 per month, which do not change with the price increase. How many disgruntled customers can Netflix lose before profitability is affected negatively? (AACSB: Communications; Analytic Reasoning) Answer: Old

New (60% increase)

$9.99

$15.98

 variable cost

$3.50

$3.50

= contribution/customer

$6.49

$12.48

Price

The 60% increase in price results in contribution from each subscriber almost doubling because variable costs remain the same. To determine how many customers can be lost before profitability is impacted negatively, we calculate how many customers must be retained at the new price level to maintain the original total contribution. Copyright©2014 Pearson Education

The original total contribution can be calculated by multiplying the original contribution by the number of subscribers: Original total contribution = $6.49 × 23 million customers = $149,270,000 Now determine the number of customers necessary to maintain that original total contribution of $149,270,000: Original total contribution = new contribution  new total customers So, New total customers

original total contribution $149,270,000 = —————————— = —————— = 11,960,737 new contribution $12.48

Thus, Netflix can lose almost half of its customers ((11,960,000 – 23,000,000) ÷ 23,000,000 = -0.4799 or 47.99% decrease) before the price increase will negatively impact profitability. 2. Is this a smart move by Netflix? Discuss the pros and cons of such a drastic price increase. (AACSB: Communication; Reflective Thinking) Answer: On an objective level, this was a smart move by Netflix. Many customers who used the streaming service more than the DVD-by-mail aspect of their service switched to the streaming-only option. Even though the price was $2.00 less, there are no variable costs for Netflix because streaming-only does not require postage costs. The company thousands of subscribers after the price increase, but by the end of 2011, Netflix had 21.76 million subscribers and most of them were streaming-only customers. So Netflix did lose customers, but the total did not drop below the 11,960,737 level calculated above that would hurt profitability. On a perceptual level, this might not have been a smart move by Netflix. Unhappy customers posted 5,000 mostly negative reactions on the company’s corporate blogs (which is the most allowed on the site). Messages containing the words ―Dear Netflix‖ resulted in that phrase being Twitter’s top ―trending topic‖ the day of the price change announcement and the comments were mostly critical.

Company Case Notes Amazon vs. Walmart: Fighting It Out Online on Price Synopsis Copyright©2014 Pearson Education

Less than a decade ago, no one considered that Amazon might someday give Walmart something to worry about. But today, Amazon is a $48 billion a year company. That’s still about a tenth of what Walmart brings in. But consider that Amazon has been growing by double digits – 40 percent last year alone. Walmart on the other hand is growing along at a pace on par with the rest of traditional retail – low single digits. Already, Amazon is cutting in to Walmart’s sales. And if this pace keeps up, Amazon could be the one to ultimately dethrone the king of retail. At the center of the battle is price. A few years ago, Walmart and Amazon got into around the holidays over price wars on everything from book and DVDs to game consoles, mobile phones, and toys. While low price may ultimately declare a winner in this game of cat and mouse, both parties also need to take extreme caution when it comes to overdoing it. In the process, both companies are trying to find other ways of outdoing each other, like personalized service and delivery options.

Teaching Objectives The teaching objectives for this case are to: 1. 2. 3. 4.

Discuss the different aspects of price. Examine the nature of establishing an image of low price. Evaluate the different ways (and outcomes) for responding to price changes. Consider the role that price plays in the marketing mix.

Questions for Discussion 1. Can consumers actually determine whether Amazon or Walmart has lower overall prices? Explain. To answer this question, consumers should consider the full concept of price. Price points are easy to compare. But factor in sales tax, shipping, fuel for the car to get to the store, and one’s time, and the picture gets a little fuzzier. Cross-comparing single items isn’t too hard, especially with today’s shopping apps. However, to come up with an answer as to which store has lower prices overall is next to impossible to answer. While some analysts might be able to provide a pretty solid picture, customers don’t buy all products. Each customer would need to know which retailer has lower prices for the types of products that they normally buy. 2. For Amazon and Walmart, is it more important to have lower prices or to have the perception of lower prices? As the famous Jack Trout quote goes, ―There are no best products. All that exists in the world of marketing are perceptions in the minds of the customer or prospect. The perception is reality. Everything else is an illusion.” For the most part, this is true. While there exists a correlation between reality and perception to some extent,

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consumers do not make decisions based on realities that do not match their perceptions. 3. Just how far should either Amazon or Walmart take the tactic of warring on price? Base your answer on Figure 11.1 in the text. Each of these companies is big enough that they can afford to lose a certain amount of money on products if they can win in the end. However, the process can result in both companies taking losses on items. The danger is conditioning consumers to expect certain pricing structures. There is definitely a point at which one company should not try to “one-up” the other in terms of price reductions. As Figure 11.1 points out, there are other possibilities including “raise perceived value,” and “improve quality and increase price.” 4. In the battle for online dominance, just how important is low price? How important are the other benefits that Amazon and Walmart each deliver? In today’s world of shopping-app enable price shopping, it would seem that having the lowest price is essential. However, a current trend in retailing is providing a full plate of options and providing a seamless transition from any one of them to another. As the case points out, Walmart has an advantage when it comes to developing and offering more ways to buy (and return). It has locations everywhere. And if it can develop some kind of reliable delivery service out of each of its stores, it can promise same-day delivery. That is something that Amazon has not yet been able to do. However, Amazon does have the benefit of endless inventories and a logistics system that selects, packages, and ships products in record time. It also has much stronger relationships with shippers like UPS and has created a seamless process where packages leave its fulfillment centers and go right on to a UPS plane. Teaching Suggestions Come up with a list of a handful of specific branded items (like a specific digital camera, TV, or pair of jeans). Post these on the board and have students quickly establish the price for each from both Amazon and Walmart. Once this has been established, ask students which company they prefer to buy from on any or all of the items As this discussion develops, take an inventory of how important rock-bottom price is for this group of shoppers. This case goes well with the first pricing chapter (Chapter 10), the retailing chapter (Chapter 13), and the online chapter (Chapter 17).

ADDITIONAL PROJECTS, ASSIGNMENTS, AND EXAMPLES Projects 1. Create a scenario for the use of a market-skimming strategy. Create a second for a marketpenetration strategy. (Objective 1) 2. Using the categories found in Table 11.1, find an advertisement that illustrates each of the strategies. Demonstrate why the advertisement fits the category. (Objective 2) Copyright©2014 Pearson Education

3. The opening vignette deals with a unique price and value strategy. Think of two other restaurants that utilize unique price and value strategies and defend your answers. (Objective 2) 4. Product bundle pricing has the potential to bring in a lot of additional revenue. Think of three different products that rely on product bundle pricing. (Objective 2)

Small Group Assignments 1. Form students into groups of three to five. Each group should read Real Marketing 11.1: Quick, What’s a Good Price for…? Each group should then answer the following questions and share their answers with the class. (Objective 1) a. Based on this reading, how well do you believe that consumers actually understand what they are paying for products? Explain your answer. b. Explain the use of prices ending in ―9‖ to induce consumer purchases. Why do you suppose this strategy is usually so effective? c. When it comes to pricing, how level is the playing field level between the retailer and the consumer? If it is not level, what steps should the consumer take to make it more level? 2. Form students into groups of three to five. Each group should read Real Marketing 11.2: International Pricing: Targeting the Bottom of the Pyramid. Each group should then answer the following questions and share their answers with the class. (Objective 3) a. What are some of the broader societal pricing concerns faced by companies who sell products to the 4 billion people on the planet living in poverty? b. Multinational companies spend a tremendous amount of money advertising to consumers who live in abject poverty around the globe. Is this ethical? c. Do you believe that the international companies mentioned here price their product offering fairly? Explain.

Individual Assignments 1. Market-skimming pricing is used many times when companies invent new products and first introduce them to the market. Think of five ―new‖ products that you believe are employing a price skimming strategy. Back up your answers. (Objective 1)

Think-Pair-Share Consider the following questions, formulate an answer, pair with the student on your right, share your thoughts with one another, and respond to questions from the instructor. 1. Under what conditions does market-skimming pricing make sense? (Objective 1) 2. When can promotional pricing be unethical? (Objective 3) Copyright©2014 Pearson Education

3. Provide an illustration of each of the geographical pricing situations. Which is used most often in delivering products sold via the Internet? (Objective 3) 4. What is dynamic pricing and when should a company use this strategy? (Objective 3) 5. What issues should marketers anticipate with respect to buyer reactions to price changes? (Objective 4)

Outside Examples 1. Take a look at Zenith watches (www.zenith-watches.com). Take time to fully explore the company and the product offering. Next, look up a couple of merchants that carry the Zenith brand. Discuss the pricing strategies you believe Zenith is employing. (Objective 1) Possible Solution: This question requires students to combine information from the previous chapter (Chapter 10) and this chapter. Zenith is using a combination of pricing strategies. From information contained in this chapter, it is clear that Zenith is employing a marketskimming pricing strategy. Remember, that for some of the requirements of this pricing strategy to work you must have the quality and the image to support the higher price. This is where the information from Chapter 10 comes in. Zenith is using the non-price variables of quality and image to allow for the price skimming strategy to be employed. 2. Research GlaxoSmithKline, the pharmaceutical company. Now, go to their Web site (www.gsk.com) to learn about the company. Pay particular attention to sections dealing with corporate responsibility, marketing practices and their stand on providing medicine to underprivileged individuals and populations. Download their Corporate Responsibility Review and read it. Discuss how GSK is attempting to walk the line between corporate profitability and social responsibility. (Objective 4) Possible Solution: GlaxoSmithKline devotes much of its efforts to acting in a socially responsible manner. Its Web site states ―Millions of poor people in both developed and developing countries cannot obtain the medicines they need. The primary responsibility for addressing this problem rests with governments, but all stakeholders, including the pharmaceutical industry, have important contributions to make. GSK is in a position to make a major contribution to the world’s health—but we have to do this in a sustainable manner to reflect the long-term nature of the challenge and without undermining our ability to generate returns for our shareholders.‖ As you can see, there is no easy answer to where to draw the line between corporate profitability and social welfare.

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Web Resources 1. http://247.prenhall.com This is the link to the Prentice Hall support link. 2. www.bang-olufsen.com Go back to Bang & Olufsen’s homepage (you visited it in the last chapter). This is a good example of a company that has successfully employed price skimming. 3. www.ikea.com/us/en/ You can check out IKEA’s page. They are experts at using market-penetration pricing. 4. www.scion.com/ Visit Scion’s homepage and see how you can use optional-product pricing to build a vehicle that is right just for you. 5. www.overstock.com/ Go to Overstock and take a look at anything you like. This company always lists reference prices (―compare at‖) so you can see how much you are ―saving.‖ 6. www.kayak.com/ Price an airline flight between two of your favorite destinations. Repeat this tomorrow. Repeat it again in two days. Have the prices changed? Probably. This is dynamic pricing.

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