Factors Affecting Pricing Decision For the remainder of this tutorial we look at factors that affect how marketers set price. The final price for a product may be influenced by many factors which can be categorized into two main groups: Internal Factors “ When setting price, marketers must take into consideration several factors which are the result of company decisions and actions. To a large extent these factors are controllable by the company and, if necessary, can be altered. However, while the organization may have control over these factors making a quick change is not always realistic. For instance, product pricing may depend heavily on the productivity of a manufacturing facility (e.g., how much can be produced within a certain period of time). The marketer knows that increasing productivity can reduce the cost of producing each product and thus allow the marketer to potentially lower the product’s price. But increasing productivity may require major changes at the manufacturing facility that will take time (not to mention be costly) and will not translate into lower price products for a considerable period of time. External Factors “ There are a number of influencing factors which are not controlled by the company but will impact pricing decisions. Understanding these factors requires the marketer conduct research to monitor what is happening in each market the company serves since the effect of these factors can vary by market. Below we provide a detailed discussion of both internal and external factors. Internal Factors: Marketing Objectives Marketing decisions are guided by the overall objectives of the company. While we will discuss this in more detail when we cover marketing strategy in a later tutorial, for now it is important to understand that all marketing decisions, including price, work to help achieve company objectives. Corporate objectives can be wide-ranging and include different objectives for different functional areas (e.g., objectives for production, human resources, etc). While pricing decisions are influenced by many types of objectives set up for the marketing functional area, there are four key objectives in which price plays a central role. In most situations only one of these objectives will be followed, though the marketer may have different objectives for different products. The four main marketing objectives affecting price include: Return on Investment (ROI) “ A firm may set as a marketing objective the requirement that all products attain a certain percentage return on the organization’s spending on marketing the product. This level of return along with an estimate of sales will help determine appropriate pricing levels needed to meet the ROI objective. Cash Flow “ Firms may seek to set prices at a level that will insure that sales revenue will at least cover product production and marketing costs. This is most likely to occur with new products where the organizational objectives allow a new product to simply meet its expenses while efforts are made to establish the product in the market. This objective allows the marketer to worry less about product profitability and instead directs energies to building a market for the product. Market Share “ The pricing decision may be important when the firm has an objective of gaining a hold in a new market or retaining a certain percent of an existing market. For new products under this objective the price is set artificially low in order to capture a sizeable portion of the market and will be increased as the product becomes more accepted by the target market (we will discuss this marketing strategy in further detail in our next tutorial). For existing products, firms may use price decisions to insure they retain market share in instances where there is a high level of market competition and competitors who are willing to compete on price. Maximize Profits “ Older products that appeal to a market that is no longer growing may have a company objective requiring the price be set at a level that optimizes profits. This is often the case when the marketer has little incentive to introduce improvements to the product (e.g., demand for product is declining) and will continue to sell the same product at a price premium for as long as some in the market is willing to buy. Internal Factors: Marketing Strategy Marketing strategy concerns the decisions marketers make to help the company satisfy its target market and attain its business and marketing objectives. Price, of course, is one of the key marketing mix decisions and since all marketing mix decisions must work together, the final price will be impacted by how other marketing decisions are made. For instance, marketers selling high quality products would be expected to price their products in a range that will add to the perception of the product being at a high-level. It should be noted that not all companies view price as a key selling feature. Some firms, for example those seeking to be viewed as market leaders in product quality, will deemphasize price and concentrate on a strategy that highlights non-price benefits (e.g., quality, durability, service, etc.). Such non-price competition can help the company avoid potential price wars that often break out between competitive firms that follow a market share objective and use price as a key selling feature. Internal Factors: Costs For many for-profit companies, the starting point for setting a product’s price is to first determine how much it will cost to get the product to their customers. Obviously, whatever price customers pay must exceed the cost of producing a good or delivering a service otherwise the company will lose money. When analyzing cost, the marketer will consider all costs needed to get the product to market including those associated with production, marketing, distribution and company administration (e.g., office expense). These costs can be divided into two main categories: Fixed Costs “ Also referred to as overhead costs, these represent costs the marketing organization incurs that are not affected by level of production or sales. For example, for a manufacturer of writing instruments that has just built a new production facility, whether they produce one pen or one million they will still need to pay the monthly mortgage for the building. From the marketing side, fixed costs may also exist in the form of expenditure for fielding a sales force, carrying out an advertising campaign and paying a service to host the company’s website. These costs are fixed because there is a level of commitment to spending that is largely not affected by production or sales levels. Variable Costs “ These costs are directly associated with the production and sales of products and, consequently, may change as the level of production or sales changes. Typically variable costs are evaluated on a per-unit basis since the cost is directly associated with individual items. Most variable costs involve costs of items that are either components of the product (e.g., parts, packaging) or are directly associated with creating the product (e.g., electricity to run an assembly line). However, there are also marketing variable costs such as coupons, which are likely to cost the company more as sales increase (i.e., customers using the coupon). Variable costs, especially for tangible products, tend to decline as more units are produced. This is due to the producing company’s ability to purchase product components for lower prices since component suppliers often provide discounted pricing for large quantity purchases. Determining individual unit cost can be a complicated process. While variable costs are often determined on a per-unit basis, applying fixed costs to individual products is less straightforward. For example, if a company manufactures five different products in one manufacturing plant how would it distribute the plant’s fixed costs (e.g., mortgage, production workers’ cost) over the five products? In general, a company will assign fixed cost to individual products if the company can clearly associate the cost with the product, such as assigning the cost of operating production machines based on how much time it takes to produce each item. Alternatively, if it is too difficult to associate to specific products the company may simply divide the total fixed cost by production of each item and assign it on percentage basis. External Factors: Elasticity of Demand Marketers should never rest on their marketing decisions. They must continually use market research and their own judgment to determine whether marketing decisions need to be adjusted. When it comes to adjusting price, the marketer must understand what effect a change in price is likely to have on target market demand for a product. Understanding how price changes impact the market requires the marketer have a firm understanding of the concept economists call elasticity of demand, which relates to how purchase quantity changes as prices change. Elasticity is evaluated under the assumption that no other changes are being made (i.e., œall things being equal) and only price is adjusted. The logic is to see how price by itself will affect overall demand. Obviously, the chance of nothing else changing in the market but the price of one product is often unrealistic. For example, competitors may react to the marketer’s price change by changing the price on their product. Despite this, elasticity analysis does serve as a useful tool for estimating market reaction. Elasticity deals with three types of demand scenarios: Elastic Demand “ Products are considered to exist in a market that exhibits elastic demand when a certain percentage change in price results in a larger and opposite percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by greater than 10%. Inelastic Demand “ Products are considered to exist in an inelastic market when a certain percentage change in price results in a smaller and opposite percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by less than 10%. Unitary Demand “ This demand occurs when a percentage change in price results in an equal and opposite percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by 10%. For marketers the important issue with elasticity of demand is to understand how it impacts company revenue. In general the following scenarios apply to making price changes for a given type of market demand: For elastic markets “ increasing price lowers total revenue while decreasing price increases total revenue. For inelastic markets “ increasing price raises total revenue while decreasing price lowers total revenue. For unitary markets “ there is no change in revenue when price is changed. External Factors: Customer Expectations Possibly the most obvious external factors that influence price setting are the expectations of customers and channel partners. As we discussed, when it comes to making a purchase decision customers assess the overall œvalue of a product much more than they assess the price. When deciding on a price marketers need to conduct customer research to determine what œprice points are acceptable. Pricing beyond these price points could discourage customers from purchasing. Firms within the marketer’s channels of distribution also must be considered when determining price. Distribution partners expect to receive financial compensation for their efforts, which usually means they will receive a percentage of the final selling price. This percentage or margin between what they pay the marketer to acquire the product and the price they charge their customers must be sufficient for the distributor to cover their costs and also earn a desired profit. External Factors: Competitive and Other Products Marketers will undoubtedly look to market competitors for indications of how price should be set. For many marketers of consumer products researching competitive pricing is relatively easy, particularly when Internet search tools are used. Price analysis can be somewhat more complicated for products sold to the business market since final price may be affected by a number of factors including if competitors allow customers to negotiate their final price. Analysis of competition will include pricing by direct competitors, related products and primary products. Direct Competitor Pricing “ Almost all marketing decisions, including pricing, will include an evaluation of competitors’ offerings. The impact of this information on the actual setting of price will depend on the competitive nature of the market. For instance, products that dominate markets and are viewed as market leaders may not be heavily influenced by competitor pricing since they are in a commanding position to set prices as they see fit. On the other hand in markets where a clear leader does not exist, the pricing of competitive products will be carefully considered. Marketers must not only research competitive prices but must also pay close attention to how these companies will respond to the marketer’s pricing decisions. For instance, in highly competitive industries, such as gasoline or airline travel, competitors may respond quickly to competitors’ price adjustments thus reducing the effect of such changes. Related Product Pricing “ Products that offer new ways for solving customer needs may look to pricing of products that customers are currently using even though these other products may not appear to be direct competitors. For example, a marketer of a new online golf instruction service that allows customers to access golf instruction via their computer may look at prices charged by local golf professionals for in-person instruction to gauge where to set their price. While on the surface online golf instruction may not be a direct competitor to a golf instructor, marketers for the online service can use the cost of in-person instruction as a reference point for setting price. Primary Product Pricing “ As we discussed in the Product Decisions tutorial, marketers may sell products viewed as complementary to a primary product. For example, Bluetooth headsets are considered complementary to the primary product cellphones. The pricing of complementary products may be affected by pricing changes made to the primary product since customers may compare the price for complementary products based on the primary product price. For example, companies that sell accessory products for the Apple iPod may do so at a cost that is only 10% of the purchase price of the iPod. However, if Apple were to dramatically drop the price, for instance by 50%, the accessory at its present price would now be 20% of the of iPod price. This may be perceived by the market as a doubling of the accessory’s price. To maintain its perceived value the accessory marketer may need to respond to the iPod price drop by also lowering the price of the accessory. External Factors: Competitive and Other Products Marketers will undoubtedly look to market competitors for indications of how price should be set. For many marketers of consumer products researching competitive pricing is relatively easy, particularly when Internet search tools are used. Price analysis can be somewhat more complicated for products sold to the business market since final price may be affected by a number of factors including if competitors allow customers to negotiate their final price. Analysis of competition will include pricing by direct competitors, related products and primary products. Direct Competitor Pricing “ Almost all marketing decisions, including pricing, will include an evaluation of competitors’ offerings. The impact of this information on the actual setting of price will depend on the competitive nature of the market. For instance, products that dominate markets and are viewed as market leaders may not be heavily influenced by competitor pricing since they are in a commanding position to set prices as they see fit. On the other hand in markets where a clear leader does not exist, the pricing of competitive products will be carefully considered. Marketers must not only research competitive prices but must also pay close attention to how these companies will respond to the marketer’s pricing decisions. For instance, in highly competitive industries, such as gasoline or airline travel, competitors may respond quickly to competitors’ price adjustments thus reducing the effect of such changes. Related Product Pricing “ Products that offer new ways for solving customer needs may look to pricing of products that customers are currently using even though these other products may not appear to be direct competitors. For example, a marketer of a new online golf instruction service that allows customers to access golf instruction via their computer may look at prices charged by local golf professionals for in-person instruction to gauge where to set their price. While on the surface online golf instruction may not be a direct competitor to a golf instructor, marketers for the online service can use the cost of in-person instruction as a reference point for setting price. Primary Product Pricing “ As we discussed in the Product Decisions tutorial, marketers may sell products viewed as complementary to a primary product. For example, Bluetooth headsets are considered complementary to the primary product cellphones. The pricing of complementary products may be affected by pricing changes made to the primary product since customers may compare the price for complementary products based on the primary product price. For example, companies that sell accessory products for the Apple iPod may do so at a cost that is only 10% of the purchase price of the iPod. However, if Apple were to dramatically drop the price, for instance by 50%, the accessory at its present price would now be 20% of the of iPod price. This may be perceived by the market as a doubling of the accessory’s price. To maintain its perceived value the accessory marketer may need to respond to the iPod price drop by also lowering the price of the accessory. Evaluation of various Market Orientations What is it? Business orientations are classified into the following groups: Production Orientation, Product Orientation, Sales Orientation, and Marketing Orientation. Production Orientation “ Dominated the business landscapes of the industrial revolution and mid 1900²s; this is where a company is heavily focused on streamlining production processes and concentrating on improvement efficiencies with little focus on anything else. Scenario: We can build a car for you, but it comes in black only. Product Orientation “ An approach to business that centres its activities on continually improving and refining its products. All efforts are put into making the product better. Scenario: We can offer you non-chip paint on your car. Sales Orientation “ Some businesses see their main problem as not selling enough of the product or services which they already have available, hence predominantly focusing on sales and selling techniques. As a result these organisations operate as Sales Oriented companies. A sales orientated business pays little attention to customer needs and wants and is more concerned about selling. Scenario: If you sign up for the car now we’ll throw in a sunroof. Marketing Orientation “ This is a culture rather than an individual process. It’s the norms, mindsets, values and behaviours of employers; alongside the structure, systems and control of the organisation. Marketing oriented businesses define their activities as service activities carried out towards the satisfaction of their customers. In other words they define their operation as a service business with customer service being the most important activity. They are driven by customer needs which are identified in their objectives. Scenario: We’ll make your car in whatever colour you choose. When to use it? Use market orientations when you want to understand, anticipate and satisfy your customer needs. You may already be operating somewhere in-between orientations. Companies can be anywhere on the spectrum as well as having different products at different orientations. What does it achieve? A sense of what customers want Links customers needs to company capabilities Builds relationships Creates vision Greater internal marketing and communications Tracking and information systems for further research and evaluation Key steps: Audit and analyse current orientation Decide on strategy Implement full marketing mix Evaluate and control Top Tips: Being marketing orientated is more than just being customer-led. It requires the full support of the organisation in order to be fully implemented in the long term, and may need a complete change in a company’s culture. 1. Marketing Concept One of the five marketing management orientations is the marketing concept. The marketing concept is based on the belief that a company must create, deliver and market products more efficiently than the competition in order to turn a profit. To implement this concept, managers focus on researching the target market and customer’s needs along with marketing the product in an integrated manner. The production concept, the oldest marketing concept, is based on a belief that consumers prefer low prices and product availability. To implement the production concept, managers concentrate on low costs, mass distribution and high production efficiency. The production concept is mostly useful in developing countries where consumers are focused on obtaining products, rather than focused on the features of a product. Another marketing management orientation is the product concept. This concept is based on the belief that consumers prefer high-performing and high-quality products that serve an individual or unusual purpose. To implement the product concept, managers focus on producing superior products with innovative features. Typically, these products are also easily improved over time. One disadvantage of this concept is at times, managers tend to become extremely engaged with their product and lose track of what the consumer actually wants. The selling concept is based on the belief that consumers and businesses will not purchase products from companies without aggressive selling and promotional efforts. To implement this concept, managers focus on selling what the company creates rather than focusing on making what the consumers want. Managers also focus on creating a comprehensive advertisement campaign to coax consumers into purchasing their products. The final marketing management orientation is the societal, or holistic, marketing concept. This concept is similar to the marketing concept in that a company focuses on the wants, needs and interests of a target consumer market and delivers the product more effectively than any competitor delivers. The societal marketing concept is also based on the belief that a company should carry out the marketing concept in a manner that enhances or preserves society’s well-being. The societal marketing concept takes into consideration how a company’s marking affects society as a whole. Production Concept Product Concept Selling Concept Societal Marketing Concept