Multimedia Marketing/Marketing.iso/market/chapter8.1p

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SECTION 8.1  Introduction to Pricing

INSTRUCTIONS Decide what you believe to be the major factors that management
should consider in setting prices. Then go through this section for details on this subject.

EXAMPLE

In recent periods, American farmers have experienced considerable
difficulties, not the least of which has been falling prices for
many commodities. Other problems have been increasing worldwide
competition for farm products, reductions in government price
supports, and heavy debts.

Some farmers have escaped the low price trap by producing specialty
products at a premium price. A New Yorker raises deer and sells
the venison to fine restaurants in Manhatten. Other farmers are
raising Muscovy ducks and European fallow deer, planting groves
of Malaysian carambolas and Chinese lychees and harvesting African
eggplants and Japanese cucumbers.

These farmers are cashing in on Americans' increased concern with
nutrition, boredom with processed foods, and new tastes for the
exotic. The prices charged for the specialty products routinely
run double, or more, those of the standard fare routinely earned
in agribusiness.

DETAILS

Pricing is one of the most important marketing decisions that management
makes. Too high a price means that the product will not sell, while
too low a price dictates low profits or even losses. Basically,
there are three major instances when management makes pricing
decisons:

1. For new products.
2, In reaction to competitor-initiated price changes.
3. When the firm itself initiates the price changes for some reason.

The field of economics has contributed heavily to price theory. It
focuses mainly on the behavior of revenues and costs and management's
reactions to these variables as they attempt to drive the company
toward maximizing profits.

Revenues are clearly important in pricing, since they represent the
cash generated to cover the costs of producing and/or selling the
product or service, plus any profit. Revenues are a function of the
demand for the product;customers balance the cost of acquiring a
product (its price) against the anticipated benefits from owning it.
Marketers must understand the relationship between price and demand,
before making a decision on an item's price.

The seller's ability to set a price depends a good deal on the type
of market in which the product competes. There are four types of
markets: pure competition, monopolistic competition, oligopoly,
and pure monopoly. Each one represents a different pricing challenge.

Under pure competition, the market is composed of many buyers and
sellers who trade in a homogeneous commodity, such as wheat. No
single buyer or seller is large enough to have much impact on the
market's going price.

Purely competitive markets are characterized by both a high
mobility of resources and a high level of information among buyers
and sellers. This means that if a company's prices and profits
rise over the long term, buyers readily shift to buying from less
costly suppliers. Also new sellers can readily enter the market.

Sellers in these markets are price-takers, rather than price-setters.
Since sellers cannot establish a differential advantage, the role
of marketing strategy becomes diminished in importance. However,
in most markets today, marketing strategies usually give companies,
even farmers, ways of differentiating their product offerings.

Under monopolistic competition the market is composed of many buyers
and sellers who transact over a range of prices rather than at
a single market price. The reason for the price range is that sellers
are able to differentiate their offerings to buyers through differences
in style, physical distribution, or some other marketing mix element.
Because of these differences, buyers will pay different prices.

Through differentiating their offerings, some of the sellers are
able to earn a much higher rate of return than others. Their
continued success depends on their ability to establish barriers to
entry from other competitors, as through patents, advertising,
developing brand loyalty, and keeping one step ahead of the others
in developing new products. This makes all marketing activities
more important than in pure competition.

Under oligopoly, the market consists of a few sellers who are highly
sensitive to each other's pricing and other marketing strategies.
The product can be homogeneous (steel, aluminum) or hetereogeneous
(television sets). The reason there are few sellers is that there
are high barriers to entry, such as heavy capital costs, patents,
and control over distribution channels. Each seller is alert to
competitors' strategies and moves.

An oligopolistic company is never sure that it will gain anything
permanent through a price cut. But it is also never quite sure that
competitors will follow a price increase and cause a retraction.
Often competition tends to be based most heavily on nonprice means
of differentiating products, which greatly elevates the importance
of all marketing activities. Most major industries are oligopolistic
today.

Under a pure monopoly there is only one seller. The firm is free
to price at what the market will bear. However, they do not always
charge the full price for a number of reasons, including fear of
government regulation, desire not to attract competitors, and a
desire to penetrate the market faster with a low price. Pure
monopoly is rare today.

PROBLEM 1

If an industrial lubricants wholesaler is in an oligopoly-type
industry:

A. It must sell its products at the market price.
B. Competition is based most heavily on nonprice means of
   differentiating products.
C. The company can charge what the market will bear.
D. The market is composed of a large number of buyers and sellers.

WORKED

If an industrial lubricants wholesaler is in an oligopoly-type
industry, competition is based most heavily on nonprice means
of differentiating products. The wholesaler is in a market that
is dominated by a few sellers who are highly responsive to each
other's marketing activities. If the firm reduces prices, this
may set off a price war. On the other hand, if it raises prices,
competitors may not follow and the wholesaler may lose revenue.
These barriers to price administration are such that the best
way to compete is likely to be through product, promotion, and
place elements of the marketing mix.

ANSWER  B
INSTRUCTIONS Decide what you believe to be the major factors that management
should consider in setting prices. Then go through this section for details on this subject.

EXAMPLE

In recent periods, American farmers have experienced considerable
difficulties, not the least of which has been falling prices for
many commodities. Other problems have been increasing worldwide
competition for farm products, reductions in government price
supports, and heavy debts.

Some farmers have escaped the low price trap by producing specialty
products at a premium price. A New Yorker raises deer and sells
the venison to fine restaurants in Manhatten. Other farmers are
raising Muscovy ducks and European fallow deer, planting groves
of Malaysian carambolas and Chinese lychees and harvesting African
eggplants and Japanese cucumbers.

These farmers are cashing in on Americans' increased concern with
nutrition, boredom with processed foods, and new tastes for the
exotic. The prices charged for the specialty products routinely
run double, or more, those of the standard fare routinely earned
in agribusiness.

DETAILS

Price elasticity is a concept that relates to how responsive demand
will be to a change in price. If demand only changes a small amount
when price is changed, demand is said to be "inelastic". On the
other hand, if there is a sizeable increase in demand when price
is changed, demand is termed to be"elastic". Elasticity is calculated
by the formula:

Elasticity= % Change in quantity demanded/ % change in price

If the computed elasticity is a positive number, between zero and
one, demand is elastic. If it is a negative number between zero
and minus one, demand is inelastic. If the elasticity equals one,
this is called "unitary elasticity, where a price change brings
about an equal demand change.

With elastic demand, if price decreases, demand increases by a greater
percent. With an inelastic demand, demands does not increase by a
greater percent.

A good question to ask is "What determines the price elasticity
of demand?" The answer is that demand is less likely to be elastic
under the following conditions:

. When there are few or no substitutes or competitors, including
  situations involving highly segmented markets and differentiated
  products.
. When buyers do not readily perceive the relatively higher prices;
  for example if items are paid for by third parties (parents,
  insurance companies, and gifts).
. When buyers are loyal to certain brands and habits and are slow
  to search for alternatives.
. When buyers believe that the higher prices are justified by
  high quality products, normal inflation, and other factors.

If demand is elastic, sellers will probably consider lowering their
prices to increase total revenue. This is logical so long as the
costs of producing and selling additional volume do not increase
disproportionally. However, many of the activities of marketers are
designed to segment the market and position their products in such
a way as to increase the inelasticity of the demand. This reduces
the sensitivity of the product's demand to price competition.

PROBLEM 2

A tire dealer is considering dropping the prices of a premium brand
that it stocks, in order to increase demand. Which of the following
conditions would support this strategy?

A. If there is substantial competition among tire dealers.
B. If buyers are not loyal to certain tire brands.
C. If buyers are readily aware of prevailing prices.
D. If If buyers are in the habit of buying certain brands.

WORKED

A tire dealer might consider dropping the prices of a premium brand
that it stocks, in order to increase demand if buyers are readily
aware of prevailing prices. If they are aware, demand is likely to
be elastic. Consumers are not aware of prices in cases such as
when parents buy clothing for their children and individuals buy
gifts for others. Another case is for medical coverage when the
bills are paid by an insurance company and the consumer is complacent
about how much is paid. In other cases, however, consumers are very
much aware. This may be because the items are purchased frequently or
because prices are widely advertised. In the case of tires, prices
are widely advertised and it is likely that many consumers are
aware of the going price for premium brand tires. Thus, demand is likely
to be elastic and the price cut probably is justified.

ANSWER  C
INSTRUCTIONS Decide what you believe to be the major factors that management
should consider in setting prices. Then go through this section for details on this subject.

EXAMPLE

In recent periods, American farmers have experienced considerable
difficulties, not the least of which has been falling prices for
many commodities. Other problems have been increasing worldwide
competition for farm products, reductions in government price
supports, and heavy debts.

Some farmers have escaped the low price trap by producing specialty
products at a premium price. A New Yorker raises deer and sells
the venison to fine restaurants in Manhatten. Other farmers are
raising Muscovy ducks and European fallow deer, planting groves
of Malaysian carambolas and Chinese lychees and harvesting African
eggplants and Japanese cucumbers.

These farmers are cashing in on Americans' increased concern with
nutrition, boredom with processed foods, and new tastes for the
exotic. The prices charged for the specialty products routinely
run double, or more, those of the standard fare routinely earned
in agribusiness.

DETAILS

Costs are important to the pricing of a product because they set a
boundary--a floor below which prices cannot fall without causing the
company to suffer losses. Further, profit is simply a matter of the
total revenue less the cost to produce a profit, and business is very
oriented toward earning profits.

There are various types of costs that marketers consider when setting
prices. "Fixed costs" (also called overhead) are those costs that
do not vary in total as a company's volume changes. An example is
property tax on a warehouse. "Variable costs", in contrast, do vary
in total as the company's volume changes. A cereal producer has
additional costs for ingredients, packaging, and transportation for
every box of cereal that it produces. If the company increases its
output, total variable cost will also increase.

Sometimes, for pricing purposes, management finds it useful to compute
"average fixed costs". This is total fixed cost divided by the
number of units of product produced. Often average fixed cost declines
as the number of units produced increases. This effect can lead
management to adopt marketing mix strategies designed to increase
unit sales. By spreading the fixed cost over larger numbers of units,
management can sometimes lower the total unit cost.

The "average variable costs" are another variable that can be employed
for pricing purposes. This consists of total variable cost divided by
the number of units of product produced.



PROBLEM 3

Which of the following would be variable costs for a laundromat?

A. The monthly lease payment.
B. Depreciation on washers and dryers.
C. Electricity.
D. Labor cost.

WORKED

For a laundromat, electricity would be a variable cost. As more
clothing is washed and dried, more electricity is used to power
the machines. This is one of the major costs for most laundromats.
The monthly lease payment, depreciation on washers and dryers, and
labor cost stay the same, regardless of how busy the laundromat is.

ANSWER  C
INSTRUCTIONS Decide what you believe to be the major factors that management
should consider in setting prices. Then go through this section for details on this subject.

EXAMPLE

In recent periods, American farmers have experienced considerable
difficulties, not the least of which has been falling prices for
many commodities. Other problems have been increasing worldwide
competition for farm products, reductions in government price
supports, and heavy debts.

Some farmers have escaped the low price trap by producing specialty
products at a premium price. A New Yorker raises deer and sells
the venison to fine restaurants in Manhatten. Other farmers are
raising Muscovy ducks and European fallow deer, planting groves
of Malaysian carambolas and Chinese lychees and harvesting African
eggplants and Japanese cucumbers.

These farmers are cashing in on Americans' increased concern with
nutrition, boredom with processed foods, and new tastes for the
exotic. The prices charged for the specialty products routinely
run double, or more, those of the standard fare routinely earned
in agribusiness.

DETAILS

"Total costs" are the sum of fixed plus variable costs. They too
vary in total as the company's volume changes, because one of the
components--variable cost--varies proportionally with volume.

"Average costs" are the total cost of a product divided by the
total number of units considered. Average costs tend to decline
as the number of units produced increases, at least to some
point--because the overhead is spread over a larger base.

Average costs depend on long-run effects. In the relatively short-
run, say up to a year or so, average costs will fall with volume
produced and then perhaps increase somewhat. In the long-run, however,
average costs will decline further.

There are two reasons that average costs tend to fall over the long-
run as demand increases. First, "economies of scale" tend to lower
costs as volume expands over the long term. This stems from being
able to aquire and use more efficient plants and equipment, such as
heavily automated manufacturing plants and warehousing facilities.
The second reason is the "learning effect" (also called the "learning
curve" effect). The more the experience, the greater is the chance
that operations can be streamlined and made more efficient due to
greater employee familiarity with tasks, and management's expanded
experience base from which to draw in decision making.

PROBLEM 4

A producer of pastas hopes to benefit from economies of scale in its
operations. Which of the following illustrates these economies?

A. Company sales representatives find out better ways of convincing
   retailers to buy the product, with the passage of time.
B. Company marketing managers discover new segments that could be
   penetrated in future periods.
C. The producer finds that it can purchase supplies much cheaper
   from Vendor A than from Vendor B.
D. The company receives a volume discount from a supplier.

WORKED

A producer of pastas could benefit from economies of scale if it
receives a volume discount from a supplier. The volume discount means
that the more the producer buys, the lower the average cost. Hence,
as the producer expands its volume, average costs tend to fall.
Economies such as these are available only to firms that are large
enough to purchase in large quantities. These economies, then, work
in favor of large companies.

ANSWER  D