Pricing

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Date: 2014
Encyclopedia of Business and Finance
From: Encyclopedia of Business and Finance(Vol. 2. 3rd ed.)
Publisher: Gale, a Cengage Company
Document Type: Topic overview
Pages: 4
Content Level: (Level 4)

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Page 609

Pricing

Price is perhaps the most important of the four Ps (product, promotion, and place being the others) of marketing because it is the only one that generates revenue for a company. Price is most simply described as the value exchange that occurs for a product or service. Broadly, price is the total of all values exchanged for a product or service.

Price is dynamic. When establishing a price for a product or service, a company must first assess several factors regarding its potential impact. Commonly reviewed factors include legal and regulatory guidelines, pricing objectives, pricing strategies, and options for increasing sales. Advances in Internet technology have resulted in the increased use of dynamic pricing by some sellers.

LEGAL AND REGULATORY GUIDELINES

The first major law influencing the price of a company's product was the Sherman Antitrust Act of 1890, passed by Congress to prevent a company from becoming a monopoly. A monopoly occurs when one company has total control in the production and distribution of a product or service. As a monopoly, a company can charge higher than normal prices for its product or service because no significant competition exists. The Sherman Antitrust Act empowers the U.S. Attorney General's Office to challenge a perceived monopoly and to petition the federal courts to break up a company in order to promote competition.

Another significant piece of legislation that has a major effect on determining price is the Clayton Antitrust Act of 1914, passed by Congress to prevent practices such as price discrimination and the exclusive or nearly exclusive dealing between and among only a few companies. Like the Sherman Antitrust Act, this act prevented practices that would reduce competition. The Robinson-Patman Act of 1936, which is technically an extension of the Clayton Act, further prohibits a company from selling its product at an unreasonably low price to eliminate its competitors. The purpose of this act was to prohibit national chain stores from unfairly using volume discounts to drive smaller firms out of business.

To defend against charges of violating the Robinson-Patman Act, a company would have to prove that price differentials were based on the competitive free market, and not an attempt to reduce or eliminate competition. Because regulations of the Robinson-Patman Act do not apply to exported products, a company can offer products for sale at significantly lower prices in foreign markets than in U.S. markets.

Unfair- and fair-trade laws. Another set of laws influencing the price of a company's product are referred to as the unfair-trade laws. Passed during the 1930s, these laws were designed to protect special markets, such as the dairy industry, and their main focus is to set minimum retail prices for a product (e.g., milk), allowing for a slight markup. Theoretically, these laws would protect a specialty business from larger businesses that could sell the same products below cost and drive smaller, specialty stores out of business.

Fair-trade laws are a different set of statutes that were enacted by many state legislatures during the early 1930s. These laws allow a producer to set a minimum price for its product; hence, retailers signing pricing agreements with manufacturers are required to list the minimum price for which a product can be sold. These acts prevent the use of interstate pricing agreements between manufacturers and retailers, grounded in the belief that this will promote more competition and, as a result, lower prices. An important aspect of these acts is that they do not apply to intrastate product prices.

PRICING OBJECTIVES

A critical part of a company's overall strategic planning includes the establishment of pricing objectives for the products it sells. A company has four pricing objectives from which to choose, and the objective chosen will depend on the goals and type of product sold by a company. The pricing objectives are competitive, prestige, profitability, and volume pricing.

Competitive pricing. The concept behind this frequently used pricing objective is to simply match the price established by an industry leader for a particular product. Because price difference is minimized with this strategy, a company focuses its efforts on other ways to attract new customers.

Some examples of what a company might do to obtain new customers include producing high-quality and reliable products and providing superior customer service. A company could also engage in creative marketing.

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Prestige pricing. A company may chose to promote, maintain, and enhance the image of its product through the use of prestige pricing, which involves pricing a product high so as to make it available only to higher-end consumers. This limited availability enhances the product's image, causing it to be viewed as prestigious.

Although a company that uses this strategy expects to have limited sales, a profit is still possible because of the higher markup on each item. Examples of companies that use prestige pricing are Mercedes-Benz and Rolls-Royce.

Profitability pricing. The main idea behind profitability pricing is to maximize profit. The basic formula for this objective is that profits equal revenue minus expenses (P = R − E). Revenue is determined by a product's selling price and the number of units sold.

A company must be careful not to increase the price of the product too much, or the quantity sold will be reduced and total profits may be lower than desired. Therefore, a company is always monitoring the price of its products to make sure it is competitive while at the same time providing for an acceptable profit margin.

Volume pricing. When a company uses a volume-pricing objective, it is seeking sales maximization within predetermined profit guidelines. A company using this objective prices a product lower than normal but expects to make up the difference with a higher sales volume. Volume pricing can be beneficial to a company because its products are being purchased on a large scale, and large-scale product distribution helps reinforce a company's name and increase its customer loyalty.

A subset of volume pricing is the market-share objective, the purpose of which is to obtain a specific percentage of sales for a given product. A company can determine an acceptable profit margin by obtaining a specific percentage of the market with a specific price for a product.

PRICING STRATEGIES

Companies can chose from a variety of pricing strategies. Some of the most common include penetration, skimming, and competitive strategies. While each strategy is designed to achieve a different goal, each contributes to a company's ability to earn a profit.

Penetration-pricing strategy. A company that wants to build market share quickly and obtain profits from repeat sales-generally selects the penetration-pricing strategy, which can be very effective when used correctly. For example, a company may provide consumers with free samples of a product and then offer the product at a slightly reduced price. Alternatively, a company may initially offer significant discounts and then slowly remove the discounts until the full price of the product is listed.

Both options allow a company to introduce a new product and to start building customer loyalty and appreciation for it. The idea is that once consumers are familiar and satisfied with a new product, they will begin purchasing the product on a regular basis at the normal retail price. Retailers with high sales volumes frequently use this strategy. In some cases, high sales volume allows retailers to reduce prices even more.

Price-skimming strategy. A price-skimming strategy uses different pricing phases over time to generate profits. In the first phase, a company launches the product and targets customers who are more willing to pay the item's high retail price. The profit margin during this phase is extremely high and obviously generates the highest revenue for the company.

Because a company realizes that only a small percentage of the market is penetrated in the first phase, it will price the product lower in the second phase. This second-phase pricing will appeal to a broader cross-section of customers, resulting in increased product sales.

When sales start to level off during this phase, the company will price the product even lower. This third-phase pricing should appeal to those consumers who were price-sensitive in the first two phases and result in increased sales. The company should now have covered the majority of the market that is willing to purchase its product at the high-, medium-, and low-price ranges.

The price-skimming strategy provides an excellent opportunity for the company to maximize profits from the beginning and only slowly lower the price when needed because of reduced sales. Price adjustment with this strategy closely follows the product life cycle, that is, how customers accept a new product.

Price skimming is a frequently used strategy when maximum revenue is needed to pay off high research and development costs associated with some products. This strategy is effective if product image and quality support the higher price and if an adequate number of customers exist at that price. Producers of high-definition televisions have used price skimming as a strategy to maximize revenue.

Competitive-pricing strategy. Competitive pricing is yet another major strategy. A company's competitors may either increase or decrease their prices, depending on their own objectives. Before a company responds to a competitor's price change with one of its own, a thorough analysis as to why the change occurred needs to be conducted. An investigation of price increases or decreases will usually result in one or more of the following reasons for the change: a rise in the price of raw materials, higher labor costs, increasing tax rates, or rising inflation.

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To maintain an acceptable profit margin for a particular product, a company will usually increase the price. In addition, strong consumer demand for a particular product may cause a shortage and, therefore, allow a company to increase its price without hurting either demand or profit.

Response to price increase. When a competitor increases its price, a company has several options from which to chose. The first is to increase its price to approximately the same as that of the competing firm. The second is to wait before raising its price, a strategy known as price shadowing. Price shadowing allows the company to attract those new customers who are price-sensitive away from the competing firm.

If consumers do switch over in large numbers, a company will make up lost profits through higher sales volume. If consumers do not switch over after a period, the company can increase its price. Typically, a company will increase its price to a level slightly below that of its competitors in order to maintain a lower-price tactical advantage. The airline industry uses the competitive pricing strategy frequently.

Response to price decrease. When competitors decrease their prices, a company has numerous options. One option is to maintain its price, because the company is confident that consumers are loyal and value its unique product qualities. Depending on the price sensitivity of customers in a given market, this might not be an appropriate strategy for a company to use. Another option is to analyze why a competitor might have decreased its prices. If price decreases are due to a technological innovation, then a price decrease will probably be necessary because the competitor's price reduction is likely to be permanent.

Regardless of its competitor's actions, a company may decrease its price. This price reduction option is called price covering. This option is most useful when a company has done a good job of differentiating the qualities of its product from those of a competitor's product. On the flip side, the advantage of price covering is reduced when no noticeable difference can be seen between a company's product and that of a competitor.

OPTIONS FOR INCREASING SALES

Companies have several options available when attempting to increase the sales of a product, including coupons, prepayment, price shading, seasonal pricing, term pricing, segment pricing, and volume discounts.

Coupons. Almost all companies offer product coupons, reflecting their numerous advantages. First, a company might want to introduce a new product, enhance its market share, increase sales on a mature product, or revive an old product. Second, coupons can be used to generate new customers by getting customers to buy and try a company's product in the hope that these trial purchases will result in repeat purchases.

A variety of coupon distribution methods are available. These include the Internet, point-of-purchase dispensers, and Sunday newspapers.

Prepayment. A prepayment plan is typically used with customers who have no credit history or a poor one. This prepayment method does not generally provide customers with a price break, although sometimes it does.

For example, the magazine industry widely uses the prepayment strategy. A customer who agrees to purchase a magazine subscription for an extended period normally receives a discount as compared with the newsstand price. Purchase of gift certificates is another example of how prepayment can be used to promote sales. A company may offer discounts on a gift certificate whereby the purchaser may pay only 90 percent to 95 percent of the gift certificate's face value.

This strategy has several advantages. First, consumers are encouraged to buy from the company offering the gift certificates rather than from other stores. Second, the revenue is available to a company for reinvestment prior to the product's sale. Finally, receivers will not redeem all gift certificates, and as a result, a company retains all the revenue.

Price shading. One way to increase company sales is to allow salespeople to offer discounts on the product's price. This tactic, known as price shading, is normally used with aggressive buyers in industrial markets who purchase a product on a regular basis and in large volumes.

Price shading allows salespeople to offer more favorable terms to preferred business buyers. This practice is intended to encourage repeat sales.

Seasonal pricing. The price for a product can also be adjusted based on seasonal demands. Seasonal pricing will help move products when they are least salable, such as air conditioners in the winter and snow blowers in the spring.

An advantage of seasonal pricing is that the price for a product is set high during periods of high demand and lowered as seasonal demand drops off to clear inventory to make room for the current season's products. Pricing for seasonal holiday products, such as those connected with Thanksgiving and Christmas, are frequently reduced the day after the holiday to clear inventory.

Term pricing. A company has another positive reinforcement strategy for use when establishing product price: term pricing. For example, a company may offer a Page 612  |  Top of Articlediscount if the customer pays for the product promptly. The definition of promptly varies depending on company policy, but normally it means the account balance is to be paid in full within a specified period. In return, a company may provide a discount to encourage continuation of this early payment behavior by the customer.

This term pricing strategy is normally used with large retail or industrial buyers, not with the general public. Occasionally, a company will offer a small discount to customers who pay for a product with cash. For example, Gill Brothers, a furniture store located in Muncie, Indiana, occasionally offers additional discounts to customers who pay cash. During one promotional event, selected items were marked down as much as 40 percent. In addition, customers who paid by cash or check were given an extra 10 percent discount.

Segment pricing. Segment pricing is another tactic a company can use to modify product price to increase sales. Everyday examples of segment-pricing discounts are those extended to children, senior citizens, and students. These discounts have several positive benefits.

First, the company is appearing to help those individuals who are or are perceived to be economically disadvantaged, a perception that helps create a positive public relations image for a company. Second, members of those groups who ordinarily may not purchase the product are encouraged to do so. Therefore, a company's sales will increase, which will likely result in increased market share and revenue. Best Western and Marriott are examples of hotel chains that offer discounts to senior citizens.

Volume discounts. A common method used by a company to price a product is volume discounting. The idea behind this pricing strategy is simple. If a customer purchases a large volume of a product, the product is offered at a lower price.

This tactic allows a company to sell large quantities of its product at an acceptable profit margin. Volume pricing is also useful for building customer loyalty. For example, Stacks and Stacks HomeWares often provides volume discounts to customers ordering $1,000 worth of any one item.

DYNAMIC PRICING

Dynamic pricing, the strategy where price is negotiated between buyers and sellers, has been used throughout history, but its use waned when fixed pricing became popular during the later part of the 19th century. Dynamic pricing is a strategy where price is set based on the individual customer and situations.

Advances in technology such as the Internet have made modern dynamic pricing possible. Companies can mine databases to determine customer characteristics and adapt products to match buying behavior and set prices accordingly. Companies can also adjust pricing based on customer demand and product supply. The speed with which changes can be made on the Internet allows sellers to make pricing changes on a daily or even hourly basis.

Buyers can even negotiate prices with sellers via the Internet. For example, buyers can negotiate prices on products such as flights, hotel rooms, and rental cars at the website Priceline.com .

BIBLIOGRAPHY

Boone, L. E., & Kurtz, D. L. (2013). Contemporary marketing (16th ed.). Mason, OH: South-Western/Cengage Learning.

Keegan, W. J. (2013). Global marketing management (8th ed.). Upper Saddle River, NJ: Prentice Hall.

Kotler, P., & Armstrong, G. (2013). Principles of marketing (15th ed.). Upper Saddle River, NJ: Prentice Hall.

Pride, W. M., & Ferrell, O. C. (2013). Marketing 2014 (17th ed.). Mason, OH: South-Western/Cengage Learning.

Straus, J., & Frost, R. (2013). E-marketing (7th ed.). Upper Saddle River, NJ: Prentice Hall.

Allen D. Truell
Michael Milbier

Source Citation

Source Citation   (MLA 8th Edition)
Truell, Allen D., and Michael Milbier. "Pricing." Encyclopedia of Business and Finance, 3rd ed., vol. 2, Macmillan Reference USA, 2014, pp. 609-612. Gale Ebooks, https%3A%2F%2Flink.gale.com%2Fapps%2Fdoc%2FCX3727500255%2FGVRL%3Fu%3Dmnarasmuss%26sid%3DGVRL%26xid%3D4df3f095. Accessed 17 Sept. 2019.

Gale Document Number: GALE|CX3727500255

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  • Competition
    • pricing
      • 2: 609-611
  • Dynamic pricing
    • 2: 612
  • Prepayment plans
    • 2: 611
  • Price-skimming
    • 2: 610
  • Pricing
    • 2: 609-612
  • Profitability pricing
    • 2: 610
  • Segment pricing
    • 2: 612