ࡱ> XZSTUVWq` bjbjqPqP .::@QQQQxRt$jhS\TYTYTYTYTYYL Z(ggggggg$Xihkxg9^TYTY^^gTYTY$haaa^fTYTYga^gaaaTYS OZ[6Qi_aa:h0jha8l a8laa8laHZ.[a[V\HZHZHZgg a HZHZHZjh^^^^$$$&B$$$BD\< Chapter 10: Pricing Products  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET   INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/images/space.gif" \* MERGEFORMATINET  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=180" What's Ahead  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" Factors to Consider When Setting Prices  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "l2_1" Internal Factors Affecting Pricing Decision  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "l2_2" External Factors Affecting Pricing Decisions  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" General Pricing Approaches  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "l2_1" Cost-Based Pricing  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "l2_2" Value-Based Pricing  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "l2_3" Competition-Based Pricing  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=183" Chapter Wrap-Up What's AheadFor decades preceding 1995, Kellogg was beloved on Wall Streetit was a virtual money machine. The cereal giant's 1995 sales of $7 billion represented its fifty-first straight year of rising revenues. Over the previous 30 years, Kellogg's sales had grown at one and a half times the industry growth rate and its share of the U.S. cereal market had consistently exceeded 40 percent. Over the preceding decade, annual returns to shareholders had averaged 19 percent, with gross margins running as high as 55 percent. In 1995, Kellogg held a 42 percent worldwide market share, with a 48 percent share in Asia and Europe and a mind-blowing 69 percent share in Latin America. Things, it seemed, could only get better for Kellogg. Behind these dazzling numbers, however, Kellogg's cereal empire had begun to lose its luster. Much of its recent success, it now appears, had come at the expense of cereal customers. Kellogg's recent gainsand those of major competitors General Mills, Post, and Quakerhad come not from innovative new products, creative marketing programs, and operational improvements that added value for customers. Instead, these gains had come almost entirely from price increases that padded the sales and profits of the cereal makers. Throughout most of the 1980s and early 1990s, Kellogg had boosted profit margins by steadily raising prices on its Rice Krispies, Special K, Raisin Bran, and Frosted Flakesoften twice a year. For example, by early 1996, a 14-ounce box of Raisin Bran that sold for $2.39 in 1985 was going for as much as $4.00 to $5.00, but with little or no change in the costs of the materials making up the cereal or its packaging. Since World War II, no food category had had more price increases than cereal. The price increases were very profitable for Kellogg and the other cereal companieson average, the cereal makers were reaping more than twice the operating margins of the food industry as a whole. However, the relentless price increases became increasingly difficult for customers to swallow. So, not surprisingly, in 1994 the cereal industry's pricing policies began to backfire as frustrated consumers retaliated with a quiet fury. Cereal buyers began shifting away from branded cereals toward cheaper private-label brands; by 1995, private labels were devouring 10 percent of the American cereal market, up from a little more than 5 percent only five years earlier. Worse, many Americans switched to less expensive, more portable handheld breakfast foods, such as bagels, muffins, and breakfast bars. As a result, total American cereal sales began falling off by 3 to 4 percent a year. Kellogg's sales and profits sagged and its U.S. market share dropped to 36 percent. By early 1996, after what most industry analysts viewed as years of outrageous and self-serving pricing policies, Kellogg and the other cereal makers faced a full-blown crisis. Post Cereals was the first competitor to break away. Belated research showed that exorbitant pricing was indeed the cause of the industry's doldrums. "Every statistic, every survey we took only showed that our customers were becoming more and more dissatisfied," said Mark Leckie, then general manager of Post Cereals. "You can see them walking down cereal aisles, clutching fistfuls of coupons and looking all over the shelves, trying to match them with a specific brand." To boost its soggy sales, in April 1996 Post slashed the prices on its 22 cereal brands an average of 20 percenta surprise move that rocked the industry.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_01.jpg" \* MERGEFORMATINET  At first, Kellogg, General Mills, and Quaker held stubbornly to their premium prices. However, cereal buyers began switching in droves to Post's lower-priced brandsPost quickly stole 4 points from Kellogg's market share alone. Kellogg and the others had little choice but to follow Post's lead. Kellogg announced price cuts averaging 19 percent on two-thirds of all brands sold in the United States, marking the start of what would become a long and costly industry price war. In recanting their previous pricing excesses, the cereal makers swung wildly in the opposite direction, caught up in layoffs, plant closings, and other cost-cutting measures and fresh rounds of price cutting. "It reminds me of one of those World War I battles where there's all this firing but when the smoke clears you can't tell who won," noted an industry analyst. In fact, it appears that nobody won, as the fortunes of all competitors suffered. Kellogg was perhaps the hardest hit of the major competitors. Post Cereal's parent company, consumer-foods powerhouse Philip Morris, derived only about 2 percent of its sales and profits from cereals and could easily offset the losses elsewhere. However, Kellogg, which counted on domestic cereal sales for 42 percent of its revenues and 43 percent of its operating profits, suffered enormously. Its operating margins were halved, and even after lowering its prices, Kellogg's revenues and profits continued to decline. Now, several years after the initial price rollbacks, Kellogg and the cereal industry are still feeling the aftershocks. Entering the new millennium, the total American cereal market is growing at a meager 1 percent a year, private brands now capture an impressive 18 percent market share, and alternative breakfast foods continue their strong growth. Kellogg's market share has slumped to 32 percent, down from 42 percent in 1988, and its sales and profits are flat. During the past several years, Kellogg has watched its stock price languish while the stock market as a whole has more than tripled. Recently, Kellogg and the other cereal titans have quietly begun pushing ahead with modest price increases. The increases are needed, they argue, to fund the product innovation and marketing support necessary to stimulate growth in the stagnant cereal category. But there's an obvious risk. Consumers have long memories, and if the new products and programs aren't exciting enough, the higher prices may well push consumers further toward less expensive private-label cereals and alternative breakfast foods. "It's almost a no-win situation," says another analyst. Despite its problems, Kellogg remains the industry leader. The Kellogg brand name is still one of the world's best known and most respected. Kellogg's recent initiatives to cut costs, get reacquainted with its customers, and develop innovative new products and marketing programsall of which promise to add value for customers rather than simply cutting priceshas Wall Street cautiously optimistic about Kellogg's future. But events of the past five years teach an important lesson. When setting prices, as when making any other marketing decisions, a company can't afford to focus on its own costs and profits. Instead, it must focus on customers' needs and the value they receive from the company's total marketing offer. If a company doesn't give customers full value for the price they're paying, they'll go elsewhere. In this case, Kellogg stole profits by steadily raising prices without also increasing customer value. Customers paid the price in the short runbut Kellogg is paying the price in the long run. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=180" \l "#" 1 All profit organizations and many nonprofit organizations must set prices on their products or services. Price goes by many names: Price is all around us. You pay rent for your apartment, tuition for your education, and a fee to your physician or dentist. The airline, railway, taxi, and bus companies charge you a fare; the local utilities call their price a rate; and the local bank charges you interest for the money you borrow. The price for driving your car on Florida's Sunshine Parkway is a toll, and the company that insures your car charges you a premium. The guest lecturer charges an honorarium to tell you about a government official who took a bribe to help a shady character steal dues collected by a trade association. Clubs or societies to which you belong may make a special assessment to pay unusual expenses. Your regular lawyer may ask for a retainer to cover her services. The "price" of an executive is a salary, the price of a salesperson may be a commission, and the price of a worker is a wage. Finally, although economists would disagree, many of us feel that income taxes are the price we pay for the privilege of making money. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 2 In the narrowest sense,  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" price is the amount of money charged for a product or service. More broadly, price is the sum of all the values that consumers exchange for the benefits of having or using the product or service. Historically, price has been the major factor affecting buyer choice. This is still true in poorer nations, among poorer groups, and with commodity products. However, nonprice factors have become more important in buyer-choice behavior in recent decades. Throughout most of history, prices were set by negotiation between buyers and sellers. Fixed price policiessetting one price for all buyersis a relatively modern idea that arose with the development of large-scale retailing at the end of the nineteenth century. Now, some one hundred years later, the Internet promises to reverse the fixed pricing trend and take us back to an era of dynamic pricingcharging different prices depending on individual customers and situations. The Internet, corporate networks, and wireless setups are connecting sellers and buyers as never before. Web sites like Compare.Net and PriceScan.com allow buyers to quickly and easily compare products and prices. Online auction sites like eBay.com and Amazon.com make it easy for buyers and sellers to negotiate prices on thousands of itemsfrom refurbished computers to antique tin trains. At the same time, new technologies allow sellers to collect detailed data about customers' buying habits, preferenceseven spending limitsso they can tailor their products and prices. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 3 Price is the only element in the marketing mix that produces revenue; all other elements represent costs. Price is also one of the most flexible elements of the marketing mix. Unlike product features and channel commitments, price can be changed quickly. At the same time, pricing and price competition is the number-one problem facing many marketing executives. Yet, as the chapter-opening Kellogg example illustrates, many companies do not handle pricing well. The most common mistakes are pricing that is too cost oriented rather than customer-value oriented; prices that are not revised often enough to reflect market changes; pricing that does not take the rest of the marketing mix into account; and prices that are not varied enough for different products, market segments, and purchase occasions. In this chapter and the next, we focus on the problem of setting prices. This chapter looks at the factors marketers must consider when setting prices and at general pricing approaches. In the next chapter, we examine pricing strategies for new-product pricing, product mix pricing, price adjustments for buyer and situational factors, and price changes.  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/H1art2.gif" \* MERGEFORMATINET Factors to Consider When Setting PricesA company's pricing decisions are affected by both internal company factors and external environmental factors (see Figure 10.1). HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 4  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_02.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Figure 10.1Factors affecting price decisionsInternal Factors Affecting Pricing Decision Internal factors affecting pricing include the company's marketing objectives, marketing mix strategy, costs, and organizational considerations. Marketing Objectives Before setting price, the company must decide on its strategy for the product. If the company has selected its target market and positioning carefully, then its marketing mix strategy, including price, will be fairly straightforward. For example, if General Motors decides to produce a new sports car to compete with European sports cars in the high-income segment, this suggests charging a high price. Motel 6, Econo Lodge, and Red Roof Inn have positioned themselves as motels that provide economical rooms for budget-minded travelers; this position requires charging a low price. Thus, pricing strategy is largely determined by decisions on market positioning. At the same time, the company may seek additional objectives. The clearer a firm is about its objectives, the easier it is to set price. Examples of common objectives are survival, current profit maximization, market share leadership, and product quality leadership.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_03.jpg" \* MERGEFORMATINET Product-quality leadership: Maytag targets the higher quality end of the appliance market. Its ads use the long-running slogan "Built to last longer" and feature Ol' Lonely, the Maytag repairman.Companies set survival as their major objective if they are troubled by too much capacity, heavy competition, or changing consumer wants. To keep a plant going, a company may set a low price, hoping to increase demand. In this case, profits are less important than survival. As long as their prices cover variable costs and some fixed costs, they can stay in business. However, survival is only a short-term objective. In the long run, the firm must learn how to add value that consumers will pay for or face extinction. Many companies use current profit maximization as their pricing goal. They estimate what demand and costs will be at different prices and choose the price that will produce the maximum current profit, cash flow, or return on investment. In all cases, the company wants current financial results rather than long-run performance. Other companies want to obtain market share leadership. They believe that the company with the largest market share will enjoy the lowest costs and highest long-run profit. To become the market share leader, these firms set prices as low as possible.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#"  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/Example.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Consider how one major corporation benefited from current profit maximization.A company might decide that it wants to achieve product quality leadership. This normally calls for charging a high price to cover higher performance quality and the high cost of R&D. For example, Hewlett-Packard focuses on the high-quality, high-price end of the hand-held calculator market. Gillette's product superiority lets it price its Mach3 razor cartridges at a 50 percent premium over its own SensorExcel and competitors' cartridges. Maytag has long built high-quality washing machines and priced them higher. Its ads use the long-running Maytag slogan "Built to last longer" and feature the lonely Maytag repairman (who's lonely because no one ever calls him for service). The ads point out that washers are custodians of what is often a $300 to $400 load of clothes, making them worth the higher price tag. For instance, at $1,099, Maytag's new Neptune, a front-loading washer without an agitator, sells for double what most other washers cost because the company's marketers claim that it uses less water and electricity and prolongs the life of clothing by being less abrasive. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 5 A company might also use price to attain other, more specific objectives. It can set prices low to prevent competition from entering the market or set prices at competitors' levels to stabilize the market. Prices can be set to keep the loyalty and support of resellers or to avoid government intervention. Prices can be reduced temporarily to create excitement for a product or to draw more customers into a retail store. One product may be priced to help the sales of other products in the company's line. Thus, pricing may play an important role in helping to accomplish the company's objectives at many levels. Nonprofit and public organizations may adopt a number of other pricing objectives. A university aims for partial cost recovery, knowing that it must rely on private gifts and public grants to cover the remaining costs. A nonprofit hospital may aim for full cost recovery in its pricing. A nonprofit theater company may price its productions to fill the maximum number of theater seats. A social service agency may set a social price geared to the varying income situations of different clients. Marketing Mix Strategy Price is only one of the marketing mix tools that a company uses to achieve its marketing objectives. Price decisions must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective marketing program. Decisions made for other marketing mix variables may affect pricing decisions. For example, producers using many resellers who are expected to support and promote their products may have to build larger reseller margins into their prices. The decision to position the product on high-performance quality will mean that the seller must charge a higher price to cover higher costs. Companies often position their products on price and then base other marketing mix decisions on the prices they want to charge. Here, price is a crucial product-positioning factor that defines the product's market, competition, and design. Many firms support such price-positioning strategies with a technique called  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" target costing, a potent strategic weapon. Target costing reverses the usual process of first designing a new product, determining its cost, and then asking, "Can we sell it for that?" Instead, it starts with an ideal selling price based on customer considerations, then targets costs that will ensure that the price is met. The original Swatch watch provides a good example of target costing. Rather than starting with its own costs, Swatch surveyed the market and identified an unserved segment of watch buyers who wanted "a low-cost fashion accessory that also keeps time." Armed with this information about market needs, Swatch set out to give consumers the watch they wanted at a price they were willing to pay, and it managed the new product's costs accordingly. Like most watch buyers, targeted consumers were concerned about precision, reliability, and durability. However, they were also concerned about fashion and affordability. To keep costs down, Swatch designed fashionable simpler watches that contained fewer parts and that were constructed from high-tech but less expensive materials. It then developed a revolutionary automated process for mass producing the new watches and exercised strict cost controls throughout the manufacturing process. By managing costs carefully, Swatch was able to create a watch that offered just the right blend of fashion and function at a price consumers were willing to pay. As a result of its initial major success, consumers have placed increasing value on Swatch products, allowing the company to introduce successively higher-priced designs. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 6 Other companies deemphasize price and use other marketing mix tools to create nonprice positions. Often, the best strategy is not to charge the lowest price, but rather to differentiate the marketing offer to make it worth a higher price. For example, for years Johnson Controls, a producer of climate-control systems for office buildings, used initial price as its primary competitive tool. However, research showed that customers were more concerned about the total cost of installing and maintaining a system than about its initial price. Repairing broken systems was expensive, time-consuming, and risky. Customers had to shut down the heat or air conditioning in the whole building, disconnect a lot of wires, and face the dangers of electrocution. Johnson decided to change its strategy. It designed an entirely new system called "Metasys." To repair the new system, customers need only pull out an old plastic module and slip in a new oneno tools required. Metasys costs more to make than the old system, and customers pay a higher initial price, but it costs less to install and maintain. Despite its higher asking price, the new Metasys system brought in $500 million in revenues in its first year. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 7 Thus, the marketer must consider the total marketing mix when setting prices. If the product is positioned on nonprice factors, then decisions about quality, promotion, and distribution will strongly affect price. If price is a crucial positioning factor, then price will strongly affect decisions made about the other marketing mix elements. However, even when featuring price, marketers need to remember that customers rarely buy on price alone. Instead, they seek products that give them the best value in terms of benefits received for the price paid. Thus, in most cases, the company will consider price along with all the other marketing-mix elements when developing the marketing program. Costs Costs set the floor for the price that the company can charge for its product. The company wants to charge a price that both covers all its costs for producing, distributing, and selling the product and delivers a fair rate of return for its effort and risk. A company's costs may be an important element in its pricing strategy. Many companies, such as Southwest Airlines, Wal-Mart, and Union Carbide, work to become the "low-cost producers" in their industries. Companies with lower costs can set lower prices that result in greater sales and profits. Types of Costs A company's costs take two forms, fixed and variable.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" Fixed costs (also known as overhead) are costs that do not vary with production or sales level. For example, a company must pay each month's bills for rent, heat, interest, and executive salaries, whatever the company's output.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" Variable costs vary directly with the level of production. Each personal computer produced by Compaq involves a cost of computer chips, wires, plastic, packaging, and other inputs. These costs tend to be the same for each unit produced. They are called variable because their total varies with the number of units produced.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" Total costs are the sum of the fixed and variable costs for any given level of production. Management wants to charge a price that will at least cover the total production costs at a given level of production. The company must watch its costs carefully. If it costs the company more than competitors to produce and sell its product, the company will have to charge a higher price or make less profit, putting it at a competitive disadvantage. Costs at Different Levels of Production To price wisely, management needs to know how its costs vary with different levels of production. For example, suppose Texas Instruments (TI) has built a plant to produce 1,000 calculators per day. Figure 10.2a shows the typical short-run average cost curve (SRAC). It shows that the cost per calculator is high if TI's factory produces only a few per day. But as production moves up to 1,000 calculators per day, average cost falls. This is because fixed costs are spread over more units, with each one bearing a smaller share of the fixed cost. TI can try to produce more than 1,000 calculators per day, but average costs will increase because the plant becomes inefficient. Workers have to wait for machines, the machines break down more often, and workers get in each other's way.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_04.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Figure 10.2Cost per unit at different levels of production per periodIf TI believed it could sell 2,000 calculators a day, it should consider building a larger plant. The plant would use more efficient machinery and work arrangements. Also, the unit cost of producing 2,000 calculators per day would be lower than the unit cost of producing 1,000 units per day, as shown in the long-run average cost (LRAC) curve (Figure 10.2b). In fact, a 3,000-unit capacity plant would even be more efficient, according to Figure 10.2b. But a 4,000-unit daily production plant would be less efficient because of increasing diseconomies of scaletoo many workers to manage, paperwork slows things down, and so on. Figure 10.2b shows that a 3,000-unit daily production plant is the best size to build if demand is strong enough to support this level of production. Costs as a Function of Production Experience Suppose TI runs a plant that produces 3,000 calculators per day. As TI gains experience in producing calculators, it learns how to do it better. Workers learn shortcuts and become more familiar with their equipment. With practice, the work becomes better organized, and TI finds better equipment and production processes. With higher volume, TI becomes more efficient and gains economies of scale. As a result, average cost tends to fall with accumulated production experience. This is shown in Figure 10.3. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 8 Thus, the average cost of producing the first 100,000 calculators is $10 per calculator. When the company has produced the first 200,000 calculators, the average cost has fallen to $9. After its accumulated production experience doubles again to 400,000, the average cost is $7. This drop in the average cost with accumulated production experience is called the  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" experience curve (or the learning curve).  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_05.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Figure 10.3Cost per unit as a function of accumulated production: The experience curveIf a downward-sloping experience curve exists, this is highly significant for the company. Not only will the company's unit production cost fall, but it will fall faster if the company makes and sells more during a given time period. But the market has to stand ready to buy the higher output. To take advantage of the experience curve, TI must get a large market share early in the product's life cycle. This suggests the following pricing strategy. TI should price its calculators low; its sales will then increase, and its costs will decrease through gaining more experience, and then it can lower its prices further. Some companies have built successful strategies around the experience curve. For example, Bausch & Lomb solidified its position in the soft contact lens market by using computerized lens design and steadily expanding its one Soflens plant. As a result, its market share climbed steadily to 65 percent. However, a single-minded focus on reducing costs and exploiting the experience curve will not always work. Experience curve pricing carries some major risks. The aggressive pricing might give the product a cheap image. The strategy also assumes that competitors are weak and not willing to fight it out by meeting the company's price cuts. Finally, while the company is building volume under one technology, a competitor may find a lower-cost technology that lets it start at prices lower than the market leader's, who still operates on the old experience curve.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#"  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/Poll.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Give your opinion regarding pricing and market power.Organizational Considerations Management must decide who within the organization should set prices. Companies handle pricing in a variety of ways. In small companies, prices are often set by top management rather than by the marketing or sales departments. In large companies, pricing is typically handled by divisional or product line managers. In industrial markets, salespeople may be allowed to negotiate with customers within certain price ranges. Even so, top management sets the pricing objectives and policies, and it often approves the prices proposed by lower-level management or salespeople. In industries in which pricing is a key factor (aerospace, railroads, oil companies), companies often have a pricing department to set the best prices or help others in setting them. This department reports to the marketing department or top management. Others who have an influence on pricing include sales managers, production managers, finance managers, and accountants. External Factors Affecting Pricing Decisions External factors that affect pricing decisions include the nature of the market and demand, competition, and other environmental elements. The Market and Demand Whereas costs set the lower limit of prices, the market and demand set the upper limit. Both consumer and industrial buyers balance the price of a product or service against the benefits of owning it. Thus, before setting prices, the marketer must understand the relationship between price and demand for its product. In this section, we explain how the pricedemand relationship varies for different types of markets and how buyer perceptions of price affect the pricing decision. We then discuss methods for measuring the pricedemand relationship. Pricing in Different Types of Markets The seller's pricing freedom varies with different types of markets. Economists recognize four types of markets, each presenting a different pricing challenge. Under pure competition, the market consists of many buyers and sellers trading in a uniform commodity such as wheat, copper, or financial securities. No single buyer or seller has much effect on the going market price. A seller cannot charge more than the going price because buyers can obtain as much as they need at the going price. Nor would sellers charge less than the market price because they can sell all they want at this price. If price and profits rise, new sellers can easily enter the market. In a purely competitive market, marketing research, product development, pricing, advertising, and sales promotion play little or no role. Thus, sellers in these markets do not spend much time on marketing strategy. Under monopolistic competition, the market consists of many buyers and sellers who trade over a range of prices rather than a single market price. A range of prices occurs because sellers can differentiate their offers to buyers. Either the physical product can be varied in quality, features, or style, or the accompanying services can be varied. Buyers see differences in sellers' products and will pay different prices for them. Sellers try to develop differentiated offers for different customer segments and, in addition to price, freely use branding, advertising, and personal selling to set their offers apart. For example, H.J. Heinz, Vlasic, and several other national brands of pickles compete with dozens of regional and local brands, all differentiated by price and nonprice factors. In services, Kinko's differentiates its offer through strong branding and advertising, reducing the impact of pricing. Because there are many competitors in such markets, each firm is less affected by competitors' marketing strategies than in oligopolistic markets.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_06.jpg" \* MERGEFORMATINET Monopolistic competition: Kinko's differentiates its offer through strong branding and advertising, reducing the impact of pricing.Under oligopolistic competition, the market consists of a few sellers who are highly sensitive to each other's pricing and marketing strategies. The product can be uniform (steel, aluminum) or nonuniform (cars, computers). There are few sellers because it is difficult for new sellers to enter the market. Each seller is alert to competitors' strategies and moves. If a steel company slashes its price by 10 percent, buyers will quickly switch to this supplier. The other steelmakers must respond by lowering their prices or increasing their services. An oligopolist is never sure that it will gain anything permanent through a price cut. In contrast, if an oligopolist raises its price, its competitors might not follow this lead. The oligopolist then would have to retract its price increase or risk losing customers to competitors. In a pure monopoly, the market consists of one seller. The seller may be a government monopoly (the U.S. Postal Service), a private regulated monopoly (a power company), or a private nonregulated monopoly (DuPont when it introduced nylon). Pricing is handled differently in each case. A government monopoly can pursue a variety of pricing objectives. It might set a price below cost because the product is important to buyers who cannot afford to pay full cost. Or the price might be set either to cover costs or to produce good revenue. It can even be set quite high to slow down consumption. In a regulated monopoly, the government permits the company to set rates that will yield a "fair return," one that will let the company maintain and expand its operations as needed. Nonregulated monopolies are free to price at what the market will bear. However, they do not always charge the full price for a number of reasons: a desire to not attract competition, a desire to penetrate the market faster with a low price, or a fear of government regulation. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 9 Consumer Perceptions of Price and Value In the end, the consumer will decide whether a product's price is right. Pricing decisions, like other marketing mix decisions, must be buyer oriented. When consumers buy a product, they exchange something of value (the price) to get something of value (the benefits of having or using the product). Effective, buyer-oriented pricing involves understanding how much value consumers place on the benefits they receive from the product and setting a price that fits this value. A company often finds it hard to measure the values customers will attach to its product. For example, calculating the cost of ingredients in a meal at a fancy restaurant is relatively easy. But assigning a value to other satisfactions such as taste, environment, relaxation, conversation, and status is very hard. These values will vary both for different consumers and different situations. Still, consumers will use these values to evaluate a product's price. If customers perceive that the price is greater than the product's value, they will not buy the product. If consumers perceive that the price is below the product's value, they will buy it, but the seller loses profit opportunities.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#"  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/Exercise.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Consider some consequences of changing consumer perceptions of price and value.Analyzing the PriceDemand Relationship Each price the company might charge will lead to a different level of demand. The relationship between the price charged and the resulting demand level is shown in the  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" demand curve in Figure 10.4. The demand curve shows the number of units the market will buy in a given time period at different prices that might be charged. In the normal case, demand and price are inversely related; that is, the higher the price, the lower the demand. Thus, the company would sell less if it raised its price from P1 to P2. In short, consumers with limited budgets probably will buy less of something if its price is too high.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_07.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Figure 10.4Demand curvesIn the case of prestige goods, the demand curve sometimes slopes upward. Consumers think that higher prices mean more quality. For example, Gibson Guitar Corporation recently toyed with the idea of lowering its prices to compete more effectively with Japanese rivals like Yamaha and Ibanez. To its surprise, Gibson found that its instruments didn't sell as well at lower prices. "We had an inverse [pricedemand relationship]," noted Gibson's chief executive officer. "The more we charged, the more product we sold." Gibson's slogan promises: "The world's finest musical instruments." It turns out that low prices simply aren't consistent with "Gibson's century old tradition of creating investment-quality instruments that represent the highest standards of imaginative design and masterful craftsmanship." HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 10 Still, if the company charges too high a price, the level of demand will be lower. Most companies try to measure their demand curves by estimating demand at different prices. The type of market makes a difference. In a monopoly, the demand curve shows the total market demand resulting from different prices. If the company faces competition, its demand at different prices will depend on whether competitors' prices stay constant or change with the company's own prices. In measuring the pricedemand relationship, the market researcher must not allow other factors affecting demand to vary. For example, if Sony increased its advertising at the same time that it lowered its television prices, we would not know how much of the increased demand was due to the lower prices and how much was due to the increased advertising. The same problem arises if a holiday weekend occurs when the lower price is setmore gift giving over the holidays causes people to buy more televisions. Economists show the impact of nonprice factors on demand through shifts in the demand curve rather than movements along it.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#"  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/Example.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Take a moment to consider the price-demand relationship in the sports world.Price Elasticity of Demand Marketers also need to know  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" price elasticityhow responsive demand will be to a change in price. Consider the two demand curves in Figure 10.4. In Figure 10.4a, a price increase from P1 to P2 leads to a relatively small drop in demand from Q1 to Q2. In Figure 10.4b, however, the same price increase leads to a large drop in demand from Q2 1 to Q2 2. If demand hardly changes with a small change in price, we say the demand is inelastic. If demand changes greatly, we say the demand is elastic. The price elasticity of demand is given by the following formula:  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_01F.gif" \* MERGEFORMATINET  Suppose demand falls by 10 percent when a seller raises its price by 2 percent. Price elasticity of demand is therefore 5 (the minus sign confirms the inverse relation between price and demand) and demand is elastic. If demand falls by 2 percent with a 2 percent increase in price, then elasticity is 1. In this case, the seller's total revenue stays the same: The seller sells fewer items but at a higher price that preserves the same total revenue. If demand falls by 1 percent when price is increased by 2 percent, then elasticity is and demand is inelastic. The less elastic the demand, the more it pays for the seller to raise the price. What determines the price elasticity of demand? Buyers are less price sensitive when the product they are buying is unique or when it is high in quality, prestige, or exclusiveness. They are also less price sensitive when substitute products are hard to find or when they cannot easily compare the quality of substitutes. Finally, buyers are less price sensitive when the total expenditure for a product is low relative to their income or when the cost is shared by another party. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 11 If demand is elastic rather than inelastic, sellers will consider lowering their price. A lower price will produce more total revenue. This practice makes sense as long as the extra costs of producing and selling more do not exceed the extra revenue. At the same time, most firms want to avoid pricing that turns their products into commodities. In recent years, forces such as deregulation and the instant price comparisons afforded by the Internet and other technologies have increased consumer price sensitivity, turning products ranging from telephones and computers to new automobiles into commodities in consumers' eyes. Marketers need to work harder than ever to differentiate their offerings when a dozen competitors are selling virtually the same product at a comparable or lower price. More than ever, companies need to understand the price sensitivity of their customers and prospects and the trade-offs people are willing to make between price and product characteristics. In the words of marketing consultant Kevin Clancy, those who target only the price sensitive are "leaving money on the table." Even in the energy marketplace, where you would think that a kilowatt is a kilowatt is a kilowatt, some utility companies are beginning to wake up to this fact. They are differentiating their power, branding it, marketing it, and providing unique services to customers, even if it means higher prices. For example, Green Mountain Power (GMP), a small Vermont utility, is approaching the deregulated consumer energy marketplace with the firm belief that even kilowatt hours can be differentiated. GMP conducted extensive marketing research and uncovered a large segment of prospects who were not only concerned with the environment but were willing to support their attitudes with dollars. Because GMP is a "green" power providera large percentage of its power is hydroelectriccustomers had an opportunity to ease the environmental burden by purchasing GMP power. GMP has already participated in two residential power-selling pilot projects in Massachusetts and New Hampshire, successfully competing against "cheaper" brands that focused on more price-sensitive consumers. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=184" \l "#" 12 Competitors' Costs, Prices, and Offers Another external factor affecting the company's pricing decisions is competitors' costs and prices and possible competitor reactions to the company's own pricing moves. A consumer who is considering the purchase of a Canon camera will evaluate Canon's price and value against the prices and values of comparable products made by Nikon, Minolta, Pentax, and others. In addition, the company's pricing strategy may affect the nature of the competition it faces. If Canon follows a high-price, high-margin strategy, it may attract competition. A low-price, low-margin strategy, however, may stop competitors or drive them out of the market. Canon needs to benchmark its costs against its competitors' costs to learn whether it is operating at a cost advantage or disadvantage. It also needs to learn the price and quality of each competitor's offer. Once Canon is aware of competitors' prices and offers, it can use them as a starting point for its own pricing. If Canon's cameras are similar to Nikon's, it will have to price close to Nikon or lose sales. If Canon's cameras are not as good as Nikon's, the firm will not be able to charge as much. If Canon's products are better than Nikon's, it can charge more. Basically, Canon will use price to position its offer relative to the competition. Other External Factors When setting prices, the company also must consider other factors in its external environment. Economic conditions can have a strong impact on the firm's pricing strategies. Economic factors such as boom or recession, inflation, and interest rates affect pricing decisions because they affect both the costs of producing a product and consumer perceptions of the product's price and value. The company must also consider what impact its prices will have on other parties in its environment. How will resellers react to various prices? The company should set prices that give resellers a fair profit, encourage their support, and help them to sell the product effectively. The government is another important external influence on pricing decisions. Finally, social concerns may have to be taken into account. In setting prices, a company's short-term sales, market share, and profit goals may have to be tempered by broader societal considerations. General Pricing ApproachesThe price the company charges will be somewhere between one that is too low to produce a profit and one that is too high to produce any demand. Figure 10.5 summarizes the major considerations in setting price. Product costs set a floor to the price; consumer perceptions of the product's value set the ceiling. The company must consider competitors' prices and other external and internal factors to find the best price between these two extremes.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_09.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Figure 10.5Major considerations in setting priceCompanies set prices by selecting a general pricing approach that includes one or more of three sets of factors. We examine these approaches: the cost-based approach (cost-plus pricing, break-even analysis, and target profit pricing); the buyer-based approach (value-based pricing); and the competition-based approach (going-rate and sealed-bid pricing). Cost-Based Pricing Cost-Plus Pricing The simplest pricing method is  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" cost-plus pricingadding a standard markup to the cost of the product. Construction companies, for example, submit job bids by estimating the total project cost and adding a standard markup for profit. Lawyers, accountants, and other professionals typically price by adding a standard markup to their costs. Some sellers tell their customers they will charge cost plus a specified markup; for example, aerospace companies price this way to the government. To illustrate markup pricing, suppose a toaster manufacturer had the following costs and expected sales: Variable cost$10Fixed costs$300,000Expected unit sales50,000Then the manufacturer's cost per toaster is given by:  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_02F.gif" \* MERGEFORMATINET  Now suppose the manufacturer wants to earn a 20 percent markup on sales. The manufacturer's markup price is given by: HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" 13  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_03F.gif" \* MERGEFORMATINET  The manufacturer would charge dealers $20 a toaster and make a profit of $4 per unit. The dealers, in turn, will mark up the toaster. If dealers want to earn 50 percent on sales price, they will mark up the toaster to $40 ($20 + 50% of $40). This number is equivalent to a markup on cost of 100 percent ($20/$20). Does using standard markups to set prices make sense? Generally, no. Any pricing method that ignores demand and competitor prices is not likely to lead to the best price. Suppose the toaster manufacturer charged $20 but sold only 30,000 toasters instead of 50,000. Then the unit cost would have been higher because the fixed costs are spread over fewer units, and the realized percentage markup on sales would have been lower. Markup pricing works only if that price actually brings in the expected level of sales. Still, markup pricing remains popular for many reasons. First, sellers are more certain about costs than about demand. By tying the price to cost, sellers simplify pricingthey do not have to make frequent adjustments as demand changes. Second, when all firms in the industry use this pricing method, prices tend to be similar and price competition is thus minimized. Third, many people feel that cost-plus pricing is fairer to both buyers and sellers. Sellers earn a fair return on their investment but do not take advantage of buyers when buyers' demand becomes great. Break-even Analysis and Target Profit Pricing Another cost-oriented pricing approach is  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" break-even pricing (or a variation called  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" target profit pricing.) The firm tries to determine the price at which it will break even or make the target profit it is seeking. Such pricing is used by General Motors, which prices its automobiles to achieve a 15 to 20 percent profit on its investment. This pricing method is also used by public utilities, which are constrained to make a fair return on their investment. Target pricing uses the concept of a break-even chart, which shows the total cost and total revenue expected at different sales volume levels. Figure 10.6 shows a break-even chart for the toaster manufacturer discussed here. Fixed costs are $300,000 regardless of sales volume. Variable costs are added to fixed costs to form total costs, which rise with volume. The total revenue curve starts at zero and rises with each unit sold. The slope of the total revenue curve reflects the price of $20 per unit.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_10.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Figure 10.6Break-even chart for determining target priceThe total revenue and total cost curves cross at 30,000 units. This is the break-even volume. At $20, the company must sell at least 30,000 units to break even; that is, for total revenue to cover total cost. Break-even volume can be calculated using the following formula:  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_04F.gif" \* MERGEFORMATINET  If the company wants to make a target profit, it must sell more than 30,000 units at $20 each. Suppose the toaster manufacturer has invested $1,000,000 in the business and wants to set price to earn a 20 percent return, or $200,000. In that case, it must sell at least 50,000 units at $20 each. If the company charges a higher price, it will not need to sell as many toasters to achieve its target return. But the market may not buy even this lower volume at the higher price. Much depends on the price elasticity and competitors' prices. The manufacturer should consider different prices and estimate break-even volumes, probable demand, and profits for each. This is done in Table 10.1. The table shows that as price increases, break-even volume drops (column 2). But as price increases, demand for the toasters also falls off (column 3). At the $14 price, because the manufacturer clears only $4 per toaster ($14 less $10 in variable costs), it must sell a very high volume to break even. Even though the low price attracts many buyers, demand still falls below the high break-even point, and the manufacturer loses money. At the other extreme, with a $22 price the manufacturer clears $12 per toaster and must sell only 25,000 units to break even. But at this high price, consumers buy too few toasters, and profits are negative. The table shows that a price of $18 yields the highest profits. Note that none of the prices produce the manufacturer's target profit of $200,000. To achieve this target return, the manufacturer will have to search for ways to lower fixed or variable costs, thus lowering the break-even volume.  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Table 10.1Break-even Volume and Profits at Different Prices(1) (2) (3) (4) (5) (6) Price Unit Demand Needed to Break Even Expected Unit Demand at Given Price Total Revenues (1) (3) Total costs* Profit (4) (5) $14 75,000 71,000 $994,000 $ 1,010,000 $ 16,000 16 50,000 67,000 1,072,000 970,000 102,000 18 37,500 60,000 1,080,000 900,000 180,000 20 30,000 42,000 840,000 720,000 120,000 22 25,000 23,000 506,000 530,000 24,000 Value-Based Pricing An increasing number of companies are basing their prices on the product's perceived value.  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" Value-based pricing uses buyers' perceptions of value, not the seller's cost, as the key to pricing. Value-based pricing means that the marketer cannot design a product and marketing program and then set the price. Price is considered along with the other marketing mix variables before the marketing program is set. Figure 10.7 compares cost-based pricing with value-based pricing. Cost-based pricing is product driven. The company designs what it considers to be a good product, totals the costs of making the product, and sets a price that covers costs plus a target profit. Marketing must then convince buyers that the product's value at that price justifies its purchase. If the price turns out to be too high, the company must settle for lower markups or lower sales, both resulting in disappointing profits.  INCLUDEPICTURE "http://myphliputil.pearsoncmg.com/media/ABkotler7/chapter10/ABkotler7_10_11.gif" \* MERGEFORMATINET  INCLUDEPICTURE "http://myphlip1.pearsoncmg.com/abimages/space.gif" \* MERGEFORMATINET Figure 10.7Cost-based versus value-based pricingValue-based pricing reverses this process. The company sets its target price based on customer perceptions of the product value. The targeted value and price then drive decisions about product design and what costs can be incurred. As a result, pricing begins with analyzing consumer needs and value perceptions, and price is set to match consumers' perceived value. A company using value-based pricing must find out what value buyers assign to different competitive offers. However, measuring perceived value can be difficult. Sometimes, consumers are asked how much they would pay for a basic product and for each benefit added to the offer. Or a company might conduct experiments to test the perceived value of different product offers. If the seller charges more than the buyers' perceived value, the company's sales will suffer. Many companies overprice their products, and their products sell poorly. Other companies underprice. Underpriced products sell very well, but they produce less revenue than they would have if price were raised to the perceived-value level. During the past decade, marketers have noted a fundamental shift in consumer attitudes toward price and quality. Many companies have changed their pricing approaches to bring them into line with changing economic conditions and consumer price perceptions. According to Jack Welch, CEO of General Electric, "The value decade is upon us. If you can't sell a top-quality product at the world's best price, you're going to be out of the game. . . . The best way to hold your customers is to constantly figure out how to give them more for less." HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" 14 Thus, more and more, marketers have adopted  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" value pricing strategiesoffering just the right combination of quality and good service at a fair price. In many cases, this has involved the introduction of less expensive versions of established, brand-name products. Campbell introduced its Great Starts Budget frozen-food line, Holiday Inn opened several Holiday Express budget hotels, Revlon's Charles of the Ritz offered the Express Bar collection of affordable cosmetics, and fast-food restaurants such as Taco Bell and McDonald's offered "value menus." In other cases, value pricing has involved redesigning existing brands in order to offer more quality for a given price or the same quality for less. In many business-to-business marketing situations, the pricing challenge is to find ways to maintain the company's pricing powerits power to maintain or even raise prices without losing market share. To retain pricing powerto escape price competition and to justify higher prices and marginsa firm must retain or build the value of its marketing offer. This is especially true for suppliers of commodity products, which are characterized by little differentiation and intense price competition. In such cases, many companies adopt value-added strategies. Rather than cutting prices to match competitors, they attach value-added services to differentiate their offers and thus support higher margins. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" 15 An important type of value pricing at the retail level is everyday low pricing (EDLP). EDLP involves charging a constant, everyday low price with few or no temporary price discounts. In contrast, highlow pricing involves charging higher prices on an everyday basis but running frequent promotions to temporarily lower prices on selected items below the EDLP level. HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" 16 In recent years, highlow pricing has given way to EDLP in retail settings ranging from Saturn car dealerships to upscale department stores such as Nordstrom. Retailers adopt EDLP for many reasons, the most important of which is that constant sales and promotions are costly and have eroded consumer confidence in the credibility of everyday shelf prices. Consumers also have less time and patience for such time-honored traditions as watching for supermarket specials and clipping coupons. The king of EDLP is Wal-Mart, which practically defined the concept. Except for a few sale items every month, Wal-Mart promises everyday low prices on everything it sells. In contrast, Sears's attempts at EDLP in 1989 failed. To offer everyday low prices, a company must first have everyday low costs. Wal-Mart's EDLP strategy works well because its expenses are only 15 percent of sales. Sears, however, was spending 29 percent of sales to cover administrative and other overhead costs. As a result, Sears now offers everyday fair pricing, under which it tries to offer customers differentiated products at a consistent, fair price with fewer markdowns. Competition-Based Pricing Consumers will base their judgments of a product's value on the prices that competitors charge for similar products. One form of  HYPERLINK "http://myphlip1.pearsoncmg.com/faculty/abpage.cfm?vbcid=2766&vid=182" \l "#" competition-based pricing is going-rate pricing, in which a firm bases its price largely on competitors' prices, with less attention paid to its own costs or to demand. The firm might charge the same, more, or less than its major competitors. In oligopolistic industries that sell a commodity such as steel, paper, or fertilizer, firms normally charge the same price. The smaller firms follow the leader: They change their prices when the market leader's prices change, rather than when their own demand or costs change. Some firms may charge a bit more or less, but they hold the amount of difference constant. Thus, minor gasoline retailers usually charge a few cents less than the major oil companies, without letting the difference increase or decrease. Going-rate pricing is quite popular. When demand elasticity is hard to measure, firms feel that the going price represents the collective wisdom of the industry concerning the price that will yield a fair return. They also feel that holding to the going price will prevent harmful price wars. Competition-based pricing is also used when firms bid for jobs. Using sealed-bid pricing, a firm bases its price on how it thinks competitors will price rather than on its own costs or on the demand. The firm wants to win a contract, and winning the contract requires pricing less than other firms. Yet the firm cannot set its price below a certain level. It cannot price below cost without harming its position. In contrast, the higher the company sets its price above its costs, the lower its chance of getting the contract. Key Terms price The amount of money charged for a product or service, or the sum of the values that consumers exchange for the benefits of having or using the product or service. target costing Pricing that starts with an ideal selling price, then targets costs that will ensure that the price is met. fixed costs Costs that do not vary with production or sales level. variable costs Costs that vary directly with the level of production. total costs The sum of the fixed and variable costs for any given level of production. experience curve (learning curve) The drop in the average per-unit production cost that comes with accumulated production experience. demand curve A curve that shows the number of units the market will buy in a given time period at different prices that might be charged. price elasticity A measure of the sensitivity of demand to changes in price. cost-plus pricing Adding a standard markup to the cost of the product. break-even pricing (target profit pricing) Setting 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