Course Code
Course Name
MKT 305 Marketing Management
Session No.
Topic Date
20 Developing pricing strategies and programs
Setting the Price
A firm must set a price for the first time when it develops a new product, when it introduces its
regular product into a new distribution channel or geographical area, and when it enters bids on
new contract work. The firm must decide where to position its product on quality and price. Most
markets have three to five price points or tiers. Marriott Hotels is good at developing different
brands or variations of brands for different price points: Marriott Vacation Club—Vacation Villas
(highest price), Marriott Marquis (high price), Marriott (high-medium price), Renaissance
(medium-high price), Courtyard (medium price), TownePlace Suites (medium-low price), and
Fairfield Inn (low price). Firms devise their branding strategies to help convey the price-quality
tiers of their products or services to consumers. Having a range of price points allows a firm to
cover more of the market and to give any one consumer more choices. “Marketing Insight: Trading
Up, Down, and Over” describes how consumers have been shifting their spending in recent years.
The firm must consider many factors in setting its pricing policy. Table 16.2 summarizes the six
steps in the process.
Step 1: Selecting the Pricing Objective
The company first decides where it wants to position its market offering. The clearer a firm’s
objectives, the easier it is to set price. Five major objectives are: survival, maximum current profit,
maximum market share, maximum market skimming, and product-quality leadership.
Survival: Companies pursue survival as their major objective if they are plagued with
overcapacity, intense competition, or changing consumer wants. As long as prices cover variable
costs and some fixed costs, the company stays in business. Survival is a short-run objective; in the
long run, the firm must learn how to add value or face extinction.
Maximum Current Profit: Many companies try to set a price that will maximize current profits.
They estimate the demand and costs associated with alternative prices and choose the price that
produces maximum current profit, cash flow, or rate of return on investment. This strategy assumes
the firm knows its demand and cost functions; in reality, these are difficult to estimate. In
emphasizing current performance, the company may sacrifice long-run performance by ignoring
the effects of other marketing variables, competitors’ reactions, and legal restraints on price.
Maximum Market Share: Some companies want to maximize their market share. They believe a
higher sales volume will lead to lower unit costs and higher long-run profit, so they set the lowest
price, assuming the market is price sensitive. Texas Instruments famously practiced this market-
penetration pricing for years. The company would build a large plant, set its price as low as
possible, win a large market share, experience falling costs, and cut its price further as costs fell.
The following conditions favor adopting a market-penetration pricing strategy: (1) The market is
highly price sensitive and a low price stimulates market growth; (2) production and distribution
costs fall with accumulated production experience; and (3) a low price discourages actual and
potential competition.
Maximum Market Skimming: Companies unveiling a new technology favor setting high prices to
maximize market skimming. Sony has been a frequent practitioner of market-skimming pricing,
in which prices start high and slowly drop over time.
Product-Quality Leadership: A company might aim to be the product-quality leader in the market.
Many brands strive to be “affordable luxuries”—products or services characterized by high levels
of perceived quality, taste, and status with a price just high enough not to be out of consumers’
reach. Brands such as Starbucks, Aveda, Victoria’s Secret, BMW, and Viking have positioned
themselves as quality leaders in their categories, combining quality, luxury, and premium prices
with an intensely loyal customer base.
Step 2: Determining Demand
Each price will lead to a different level of demand and have a different impact on a company’s
marketing objectives. The normally inverse relationship between price and demand is captured in
a demand curve: The higher the price, the lower the demand. For prestige goods, the demand curve
sometimes slopes upward. Some consumers take the higher price to signify a better product.
However, if the price is too high, demand may fall.
Price Sensitivity: The demand curve shows the market’s probable purchase quantity at alternative
prices, summing the reactions of many individuals with different price sensitivities. The first step
in estimating demand is to understand what affects price sensitivity. Generally speaking, customers
are less price sensitive to low-cost items or items they buy infrequently. They are also less price
sensitive when (1) there are few or no substitutes or competitors; (2) they do not readily notice the
higher price; (3) they are slow to change their buying habits; (4) they think the higher prices are
justified; and (5) price is only a small part of the total cost of obtaining, operating, and servicing
the product over its lifetime.
Price Elasticity of Demand: Marketers need to know how responsive, or elastic, demand is to a
change in price. Consider the two demand curves in Figure 16.1. In demand curve (a), a price
increase from $10 to $15 leads to a relatively small decline in demand from 105 to 100. In demand
curve (b), the same price increase leads to a substantial drop in demand from 150 to 50. If demand
hardly changes with a small change in price, we say it is inelastic. If demand changes considerably,
it is elastic.
Step 3: Estimating Costs
Demand sets a ceiling on the price the company can charge for its product. Costs set the floor.
The company wants to charge a price that covers its cost of producing, distributing, and selling the
product, including a fair return for its effort and risk. Yet when companies price products to cover
their full costs, profitability isn’t always the net result.
Types of Costs and Levels of Production: A company’s costs take two forms, fixed and variable.
Fixed costs, also known as overhead, are costs that do not vary with production level or sales
revenue. A company must pay bills each month for rent, heat, interest, salaries, and so on,
regardless of output.
Variable costs vary directly with the level of production. For example, each tablet computer
produced by Samsung incurs the cost of plastic and glass, microprocessor chips and other
electronics, and packaging. These costs tend to be constant per unit produced, but they’re called
variable because their total varies with the number of units produced.
Total costs consist of the sum of the fixed and variable costs for any given level of production.
Average cost is the cost per unit at that level of production; it equals total costs divided by
production. Management wants to charge a price that will at least cover the total production costs
at a given level of production.
Target Costing Costs change with production scale and experience. They can also change as a
result of a concentrated effort by designers, engineers, and purchasing agents to reduce them
through target costing.
Market research establishes a new product’s desired functions and the price at which it will sell,
given its appeal and competitors’ prices. This price less desired profit margin leaves the target cost
the marketer must achieve.
Step 4: Analyzing Competitors’ Costs, Prices, and Offers
Within the range of possible prices identified by market demand and company costs, the firm must
take competitors’ costs, prices, and possible reactions into account. If the firm’s offer contains
features not offered by the nearest competitor, it should evaluate their worth to the customer and
add that value to the competitor’s price. If the competitor’s offer contains some features not offered
by the firm, the firm should subtract their value from its own price. Now the firm can decide
whether it can charge more, the same, or less than the competitor.
Value-priced competitors: Companies offering the powerful combination of low price and high
quality are capturing the hearts and wallets of consumers all over the world.47 Value players, such
as Aldi, E*TRADE Financial, JetBlue Airways, Southwest Airlines, Target, and Walmart, are
transforming the way consumers of nearly every age and income level purchase groceries, apparel,
airline tickets, financial services, and other goods and services.
Step 5: Selecting a Pricing Method
Given the customers’ demand schedule, the cost function, and competitors’ prices, the company is
now ready to select a price. Figure 16.4 summarizes the three major considerations in price setting:
Costs set a floor to the price. Competitors’ prices and the price of substitutes provide an orienting
point. Customers’ assessment of unique features establishes the price ceiling.
Markup Pricing: The most elementary pricing method is to add a standard markup to the product’s
cost. Construction companies submit job bids by estimating the total project cost and adding a
standard markup for profit. Lawyers and accountants typically price by adding a standard markup
on their time and costs.
Target-Return Pricing In target-return pricing, the firm determines the price that yields its target
rate of return on investment. Public utilities, which need to make a fair return on investment, often
use this method. Suppose the toaster manufacturer has invested $1 million in the business and
wants to set a price to earn a 20 percent ROI, specifically $200,000.
Perceived-Value Pricing An increasing number of companies now base their price on the
customer’s perceived value. Perceived value is made up of a host of inputs, such as the buyer’s
image of the product performance, the channel deliverables, the warranty quality, customer
support, and softer attributes such as the supplier’s reputation, trustworthiness, and esteem.
Companies must deliver the value promised by their value proposition, and the customer must
perceive this value. Firms use the other marketing program elements, such as advertising, sales
force, and the Internet, to communicate and enhance perceived value in buyers’ minds.
Value Pricing Companies that adopt value pricing win loyal customers by charging a fairly low
price for a high-quality offering. Value pricing is thus not a matter of simply setting lower prices;
it is a matter of reengineering the company’s operations to become a low-cost producer without
sacrificing quality to attract a large number of value-conscious customers.
EDLP A retailer using everyday low pricing (EDLP) charges a constant low price with little or
no price promotion or special sales. Constant prices eliminate week-to-week price uncertainty and
the high-low pricing of promotion-oriented competitors. In high-low pricing, the retailer charges
higher prices on an everyday basis but runs frequent promotions with prices temporarily lower
than the EDLP level.
Going-Rate Pricing In going-rate pricing, the firm bases its price largely on competitors’ prices.
In oligopolistic industries that sell a commodity such as steel, paper, or fertilizer, all firms normally
charge the same price. Smaller firms “follow the leader,” changing their prices when the market
leader’s prices change rather than when their own demand or costs change. Some may charge a
small premium or discount, but they preserve the difference. Thus, minor gasoline retailers usually
charge a few cents less per gallon than the major oil companies, without letting the difference
increase or decrease.
Step 6: Selecting the Final Price
Pricing methods narrow the range from which the company must select its final price. In selecting
that price, the company must consider additional factors, including the impact of other marketing
activities, company pricing policies, gain-and-risk-sharing pricing, and the impact of price on other
parties.
Impact of Other Marketing Activities: The final price must take into account the brand’s quality
and advertising relative to the competition. In a classic study, Paul Farris and David Reibstein
examined the relationships among relative price, relative quality, and relative advertising for 227
consumer businesses and found the following:
• Brands with average relative quality but high relative advertising budgets could charge premium
prices. Consumers were willing to pay higher prices for known rather than for unknown products.
• Brands with high relative quality and high relative advertising obtained the highest prices.
Conversely, brands with low quality and low advertising charged the lowest prices.
• For market leaders, the positive relationship between high prices and high advertising held most
strongly in the later stages of the product life cycle.
Source: Kotler, P., & Keller, K. L. (2016). Marketing Management 15th edition.
