Chapter 8 – Price
- Understand the factors in the pricing framework.
- Explain the different pricing objectives from which companies choose.
The Importance of Price
In previous chapters, we talked about the value exchange between companies and their customers that is the core of marketing. In order for companies to be profitable, they charge money for their products and services. They can get the money from the consumer or business customer, or look to investors to provide their operating revenue and offer an introductory service for free, or below a profitable point for the company.
Companies must understand what their customers are willing to pay against what is economically sustainable in light of the requirements of their private or public shareholders. Note that sometimes, the service is offered for free (e.g. Facebook) because the value exchanged is not money but information about the consumer. However, Facebook needs money to continue to operate. The monetary price is earned from advertisers who are willing to spend money on the audience they can reach by using the advertising services provided by Facebook.‡
For certain products or services such as luxury goods, the price is considered to reflect the quality of the goods or service. However, in many markets the price that a consumer pays no longer communicates reliable information about the quality of the product or service. This is due to several factors such as the ease of checking and comparing price information online, the increasing use of dynamic pricing, and the power of companies such as Wayfair or Walmart to demand a specific price from manufacturers regardless of their costs.‡
When consumers were considered to be operating with limited information about price and a handful of locations from which to make the purchase, price was thought of as a way that consumers evaluate the quality of a product (Milgrom & Roberts, 1986). Companies would set a ‘regular’ price for products sold to consumers. The price was set to ensure a profit for all partners in the supply chain from manufacturer to wholesaler to retailer. The manufacturer or retailer may offer a discount off the ‘regular’ price on a limited-time basis but typically the manufacturer ensured that the price of sale was the same across all retailers. Today, price comparison websites such as Trivago or Car Deals provide consumers with access to thousands of data points so that they can easily compare the same product or service.‡
Automatic dynamic pricing, where the price varies according to demand or target group, means that a consumer may see different prices on different websites at different times of the day and when using different browsers. Companies such as Facebook and Google deliver targeted ads where the price for the same product or service varies depending on the size or description of the target group (Bondi et al., 2021). ‡
Pricing is important. It is the way in which companies collect revenue. Profits can be increased by raising the price if costs are stable and customers are loyal or without alternatives. As a short term competitive strategy, price is a way to attract customers who were not using the product or service, or to cause competitors’ customers to switch brands. It can be used to modify consumers’ behaviour.
Pricing can be used attract new customers who are not currently using the product or service. Alternatively it can attract competitor’s customers to switch brands. Price can be managed directly by reducing the actual price the customer pays or through price discounts on purchase. Lower prices reduces the financial risk the customer may feel. Loyalty programs are another type of price reduction method. This type of price reduction is a way to reward existing customers without offering the price reduction to all customers (Shin and Sudhir, 2010). For example, a hotel may offer existing customers access to different prices or free additional services such as early check-in or late checkout if they join the hotel chain’s loyalty program. ‡
Price can attract consumers to different retailers and business customers to different suppliers. Unlike product and promotion, which may take time for the competitors to understand and replicate, price is the most visible to and easily matched. For example, Home Depot offers a price matching guarantee with Lowes and Rona. If a consumer can find the same priced product in the competitors’ store Home Depot will match that price immediately. Consequently, your product’s price alone is not likely to provide your company with a sustainable competitive advantage. ‡
However consistently reducing your price to meet the demands of customers or retailers can ultimately hurt the brand image of the product. Walmart, for example, forces its suppliers to provide their products at the price Walmart decides. That means that many suppliers will remove features from the product in order to reduce their cost and deliver the product at the price Walmart is willing to pay. A laptop may look the same to the consumer but the model sold at Walmart has fewer features than the model you might buy direct from the manufacturer, or from a specialty electronics retailer. Apple doesn’t not sell their computers at Walmart for this reason. Apple commands a high price versus the competition for their products because they have a loyal customer base and the function, benefits and quality of the product meets the customers’ expectations. ‡
Pricing can be used to modify consumers’ behavior. For example, if public policy makers would like to encourage reduction in water or electricity use, they may do so by raising prices during peak demand times. On the flip side, if a company would like to increase demand when there is little, they may also accomplish this by using pricing strategies. For example, airplane ticket prices are often lower during the off season (between October and April) when there is relatively low demand for air travel. This is also an example of dynamic pricing.‡
The price charged does not operate on its own. It should be consistent with a company’s product, promotion, and distribution strategies. Dollar stores are retail outlets that carry a wide variety of items at low fixed price points. The largest dollar store in Canada is called Dollarama. In 2021, it was the market leader with 1,356 stores across Canada (Dollarama, n.d.). It’s closest competitor is Dollar Tree with only 230 stores (Dollar Tree, n.d.). Since the two companies share a common pricing strategy, one might have thought that the two companies would have the same number of stores. However, Dollarama has been more successful due to its product selection, communication of its brand image, and the development of its retail network. ‡
Price interacts strongly with distribution (place where the product is purchased). When a consumer decides to shop at Dollarama, a low-cost retailer, they expect the prices to be lower than other retailers. If they can buy a paper notebook at Dollarama that they saw being sold for a higher price at Staples, an office supplies retailer, they use this information to reach a conclusion about what the price for that product should be. If the same notebook with the same brand has different regular prices at different locations, which price signals the quality of the notebook? Do the different prices lead consumers to think that one retailer is trying to earn more profit by charging a higher price? ‡
The Pricing Framework
Before pricing a product, a company must determine its pricing objective. The company must think about what they want to accomplish with its pricing. Companies must also estimate demand for the product or service, determine the costs and profit by analyze all factors (e.g., competition, regulations, and economy) affecting price decisions. Then, to convey a consistent image, the company should choose the most appropriate pricing strategy. A pricing strategy can be delivered using different pricing tactics. The basic steps in the pricing framework are shown in Figure 8.1 “The Pricing Framework”.
Set Pricing Objectives
Different companies want to accomplish different things with their pricing strategies. For example, one company may want to capture market share, another may be solely focused on maximizing its profits, and another may want to be perceived as having products with prestige. Some examples of different pricing objectives companies may set include profit-oriented objectives, sales-oriented objectives, and status quo objectives.
This objective focuses on profit as the key outcome.
- Earning a Targeted Return on Investment (ROI): ROI, or return on investment, is the amount of profit a company hopes to make given the amount of assets, or money, it has tied up in a product. ROI is a common pricing objective for many companies. Companies typically set a certain percentage, such as 10 %, for ROI in a product’s first year following its launch. So, for example, if a company has $100,000 invested in a product and is expecting a 10 % ROI, it would want the product’s profit to be $10,000.
- Maximizing Profits: Many companies set their prices to increase their revenues as much as possible relative to their costs. However, large revenues do not necessarily translate into higher profits. To maximize its profits, a company must also focus on cutting costs.
There are several ways to manage costs. Companies can reduce costs overall or per unit. For example, The Gap cut overall costs by more efficiently controlling and managing its inventory. It could move product between stores based on customer demand, reduce the number of sizes it carries, or restrict the number of days that a customer can return a product. Another way to cut costs is to reduce the number of retail stores being operated. During the COVID-19 pandemic, Disney closed 60 of its low performing North American retail stores, including all of its 18 stores in Canada (Dion, 2021). Other companies such as Dell, Inc., cut jobs to reduce costs which increased their profits. Large companies such as Walmart are able to use their buying power to persuade its suppliers to sell their products to Walmart for less than they sell them to other companies. In this way, Walmart can reduce the cost of the products and keep its prices lower.
Rather than cutting overall cost, another way to increase profit is to decrease the cost per unit by increasing in the number of units sold. Economies of scale refer to cost savings achieved through an increased rate of production (O’Sullivan & Sheffrin, 2003). The reason why many suppliers want to sell their products to Walmart or Amazon is because they can achieve economies of scale. ‡
This objective focuses on sales, either their own or those of their competitors, as the key outcome.
- Maximizing Sales: Maximizing sales involves pricing products to generate as much revenue as possible, regardless of what it does to a company’s profits. When companies are struggling financially, they sometimes try to generate cash quickly to pay their debts. They do so by selling off inventory or cutting prices temporarily. Such cash may be necessary to pay short-term bills, such as payroll. Maximizing sales is typically a short-term objective since profitability is not considered.
- Maximizing Market Share: Some companies try to set their prices in a way that allows them to capture a larger share of the sales in their industries. Capturing more market share doesn’t necessarily mean a company will earn higher profits. The Canadian Cannabis Market is example where some of biggest cultivators had a flat or falling market share between 2020 and 2021 because smaller cultivators took market share from them (Lamers, 2021). However, one of the market leaders, Aurora is focused on increasing its presence in high-margin customers segments, which means fewer but more profitable customers. ‡
Status Quo Objectives
- Maintaining the Status Quo: Sometimes a company’s objective may be to maintain the status quo or simply meet, or equal, its competitors’ prices or keep its current prices. Airline companies are one example. Typically when one airline raises or lowers its prices, the others all do the same. If consumers are resistant to one airline’s increased prices and extra fees for food, carry-on luggage, on board entertainment, other airlines may decide not to implement the extra charge and the airline charging the fee may drop it. Companies, of course, monitor their competitors’ prices closely when they adopt a status quo pricing objective.