Core Concepts of Marketing (2008) by John Burnett - HTML preview

Middlemen receive merchandise daily and make sales daily. As new shipments are received, the goods are marked and put into stock. Cumulative mark-up is the term applied to the difference between total dollar delivered cost of all merchandise and the total dollar price of the goods put into stock for a specified period of time. The original mark-up at which individual items are put into stock is referred to as the initial mark-up.

Maintained mark-up is another important concept. The maintained mark-up percentage is an essential figure in estimating operating profits. It also provides an indication of efficiency. Maintained mark-up, sometimes called gross cost of goods, is the difference oetwecn the actual price for which all of the merchandise is sold and the total dollar delivered cost of the goods exclusive of deductions. The maintained mark-up is typically less than the initial mark-up due to mark-downs and stock shrinkages from theft, breakage, and the like. Maintained mark-up is particularly important for seasonal merchandise that will likely be marked-down substantially at the end of the season.

Although this pricing approach may seem overly simplified, it has definite merit. The problem facing managers of certain types of businesses such as retail food stores is that they must price a very large number of items and change many of those prices frequently. The standard mark-up usually reflects historically profitable margins and provide" a good gui.deline for pricing.

To illustrate this cost-based process of pricing, let's look at the case of Johnnie Walker Black Label Scotch Whiskey. This product sells for about $30 in most liquor stores. How was this price derived?

$5.00 production, distillation, maturation + $2.50 advertising + $3.1 1 distribution + $4.39 taxes + $7.50 mark-up (retailer) + $7.50 net margin (manufacturer)

Certainly costs are an important component of pricing. No firm can make a profit until it covers its costs. However, the process of determining costs and then setting a price based on costs does not take into consideration what the customer is willing to pay at the marketplace. As a result, many companies that have set out to develop a product have fallen victim to the desire to continuously add features to the product, thus adding cost. When the product is finished, these companies add some percentage to the cost and expect customers to pay the resulting price. These companies are often disappointed, as customers are not willing to pay this cost-based price.

Break-Even Analysis

A somewhat more sophisticated approach to cost-based pricing is the break-even analysis. The information required for the formula for break-even analysis is available from the accounting records in most firms. The break-even price is the price that will produce enough revenue to cover all costs at a given level of production. Total cost can be divided into fixed and variable (total cost = fixed cost + variable cost). Recall thatfixed cost does not change as the level of production goes up or down. The rent paid for the building to house the operation might be an example. No cost is fixed in the long run, but in the short run, many expenses cannot iealistically be changed. Variable cost does change as production is increased or

244 CHAPTER 9 PRICING THE PRODUCT

decreased. For example, the cost of raw material to make ihe product will vary with production.

A second shortcoming of break-even analysis is it assumes that variable costs are constant. However, wages will increase with overtime and shipping discounts will be obtained. Third, break-even assumes that all costs can be neatly categorized as fixed or variable. Where advertising expenses are entered, break-even analysis will have a significant impact on the resulting break-even price and volume.

Target Rates of Return

Break-even pricing is a reasonable approach when there is a limit on the quantity which a finn can provide and particularly when a target return objective is sought. Assume, for example, that the firm with the costs illustrated in the previous example detennines that it can provide no more than 10,000 units of the product in the next period of operation. Furthermore, the firm has set a target for profit of 20% above total costs. Referring again to internal accounting records and the changing cost of production at near capacity levels, a new total cost curve is calculated. From the cost curve profile, management sets the desirable level of produclion at 80% of capacity or 8,000 units. From the total cost curve, it is determined that the cost for producing 8,000 units is $ 18,000. Twenty percent of $18,000 is $3,600. Adding this to the total cost at 8,000 units yields the point at that quantity through which the total revenue curve must pass. Finally, $21,600 divided by 8,000 units yields the price of $2.70 per unit; here the $3,600 in profit would be realized. The obvious shortcoming of the target return approach to pricing is the absence of any infOlmation concerning the demand for the product at the desired price. It is assumed that all of the units will be sold at the price which provides the desired return.

It would be necessary, therefore, to determine whether the desired price is in fact attractive to potential customers in the marketplace. If break-even pricing is to be used, it should be supplemented by additional information concerning customer perceptions of the relevant range of prices for the product. The source of this information would most commonly be survey research, as well as a thorough review of pricing practices by competitors in the industry. In spite of their shortcomings, break-even pricing and target return pricing are very common business practices.

Demand-Oriented Pricing

Demand-oriented pricing focuses on the nature of the demand curve for the product or service being priced. The nature of the demand curve is influenced largely by the structure of the industry in which a finn competes. That is, if a firm operates in an industry that is extremely competitive, price may be used to some strategic advantage in acquiring and maintaining market share. On the other hand, if the firm operates in an environment with a few dominant players, the range in which price can vary may be minimal.

Value-Based Pricing

If we consider the three approaches to setting price, cost-based is focused entirely OH the perspective of the company with very little concern for the customer; demand-based is focused on the customer, but only as a predictor of sales; and value-based focuses entirely on the customer as a determinant of the total price/value package. Marketers who employ value-based pricing might use the following definition: "It is what you think your product is worth to that customer at that time." Moreover, it acknowledges several marketing/price truths:

ALTERNATIVE APPROACHES TO DETERMINING PRICE 245

• To the customer, price is the only unpleasant part of buying.

• Price is the easiest marketing tool to copy.

• Price represents everything about the product.

Still, value-based pricing is not altruistic. It asks and answer, two questions: (1) what is the highest price I can charge and still make the sale? and (2) am I willing to sell at that price? The first question must take two primary factors into account: customers and competitors. The second question is influenced by two more: costs and constraints. Let's discuss each briefly.

Many customer-related factors are important in value-based pricing. For example, it is critical to understand the customer buying process. How important is price? When is it considered? How is it used? Another factor is the cost ofswitching. Have you ever watched the TV program "The Price is Right"? If you have, you know that most consumers have poor price knowledge. Moreover, their knowledge of comparable prices within a product category--e.g., ketchup-is typically worse. Soprice knowledge is a relevant factor. Finally, the marketer must assess the customers' price expectations. How much do you expect to pay for a large pizza? Color TV? DVD? Newspaper? Swimming pool? These expectations create a phenomenon called "sticker shock" as exhibited by gasoline, automobiles, and ATM fees.

A second factor influencing value-based pricing is competitors. As noted in earlier chapters, defining competition is not always easy. Of course there are like-category competitors such as Toyota and Nissan. We have already discussed the notion of pricing above, below, and at the same level of these direct competitors. However, there are also indirect competitors that consumers may use to base price comparisons. For instance, we may use the price of a vacation as a basis for buying vacation clothes. The cost of eating out is compared to the cost of groceries. There are also instances when a competitor, especially a market leader, dictates the price for everyone else. Weyerhauser determines the price for lumber. Kellogg establishes the price for cereal.

If you're building a picnic table, it is fairly easy to add up your receipts and calculate costs. For a global corporation, determining costs is a great deal more complex. For example, calculating incremental costs and identifying avoidable costs are valuable tasks. Incremental cost is the cost of producing each additional unit. If the incremental cost begins to exceed the incremental revenue, it is a clear sign to quit producing. Avoidable costs are those that are unnecessary or can be passed onto some other institution in the marketing channel. Adding costly features to a product that the customer cannot use is an example of the former. As to the latter, the banking industry has been passing certain costs onto customers.

Another consideration is opportunity costs. Because the company spent money on store remodeling, they are not able to take advantage of a discounted product purchase. Finally, costs vary from market-to-market as well as quantities sold. Research should be conducted to assess these differences.

Although it would be nice to assume that a business has the freedom to set any price it chooses, this is not always the case. There are a variety of constraints that prohibit such freedom. Some constraints are formal, such as government restrictions in respect to strategies like collusion and price-fixing. This occurs when two or more companies agree to charge the same or very similar prices. Other constraints tend to be informal. 5xamples include matching the price of competitors, a traditional price charged for a particular product, and charging a price that covers expected costs.

Ultimately, value-based pricing offers the following three tactical recommendations:

• Employ a segmented approach toward price, based on such criteria as customer type, location, and order size.

246 CHAPTER 9 PRICING THE PRODUCT

1. Approaches to determining price include:

a. Cost-plus and mark-ups

b. Demand-oriented pricing

c. Value-based approaches to pricing

• Establish highest possible price level and justify it with comparable value.

• Use price as a basis for establishing strong customer relationships.4

THE FUTURE OF PRICING

For too long, pricing decisions have been dominated by economists, discounters, and financial analysts. While making a reasonable profit remains a necessity, pricing must become a more strategic element of marketing. Smarter pricing, as portrayed by the value-based strategy, appears to represent the future. A case in point is the Ford Motor Co., which managed to earn $7.2 billion in 2000, more than any automaker in history. Despite a loss of market share, the key to their success was a 420,000-unit decrease in sales of low-margin vehicles such as Escorts and Aspires, and a 600,000-unit increase in sales of high-margin vehicles such as Crown Victorias and Explorers. Ford cut prices on its most profitable vehicles enough to spur demand, but not so much that they ceased to have attractive margins.

THE WALL STREET JOURNAL.

IN PRACTICE

Customers make judgmentr, about pricing based on perceived value, not production costs. For organizations, however, pricing determines the primary source of revenue for the business. Various market segments and their respective price sensitivities must be considered when marketers decide on a pricing strategy.

Increasingly, marketers are responsible for pricing. Marketers must understand strategies previously reserved for economlsls and financial analysts. Questions of price points, price lining, and price bundling now fall to marketers.

What do marketers need to know to price products to maximize profits and capture market share? Break-even analyses, target rates of return, and mark-ups are a few of the processes marketers must master.

To learn more about profits and pricing, click on the Interactive Journal's link to Money & Investing on the Front Section.

In this section you'll find information about interest rates, economic conditions, and venture capital. Because interest rates affect consumer spending, it is important to understand economic indicators and their impact

The Business Focus section of Marketplace is a good resource for articles that discuss various business marketing issues, including pricing.

Naming your own price is the strategy for Priceline.com. Customers name their own price for plane tickets, hotel rooms, and rental cars. Initially, the compary relished great success. Powever,ii

has recently suffered financial losses, due in part to the "Name Your Own Price" strategy. Visit the site now at www.priceline.com.

Facilitating exchanges between customers is a successful business strategy for eBay. Calling itself "the worid's online marketplace," eBay has created a trading medium for anyone interested in buying or selling items online. Items range from one-of-a-kind collectibles to everyday items such as musical instruments and sporting goods. Check out the Web site now at www.ebay.com.

DELIVERABLE

The airline industry competes heavily on price. Select two airlines and research fares for one round trip tie'eet on each airline, any destination. Visit several Web sites that sell airline tickets and compare fares. Compare these prices to those offered on the airlines' Web sites. Check your local newspaper for fare prices, too. Write a one-page overview of your findings.

DISCUSSION QUESTIONS

1. How do organizations decide whether to price to meet, price above, or price below competi-lion? How do organizations measure the success or failure of their chosen strategy?

2. Are you price sensitive to any products? Do you engage in conparative shopping, searching for the "beSi deal"?

3. How has the Internet affected pricing strategies? How do Internet companies compete with traditional "brick and mortar" companies in pricing?

248 CHAPTER 9 PRICING THE PRODUCT

SUMMARY

The chapter begins by defining price from the perspective of the consumer, society, and the business. Each contributes to our understanding of price and positions it as a competitive advantage.

The objectives of price are fivefold: (1) survival, (2) profit, (3) sales, (4) market share, and (5) image. In addition, a pricing strategy can target to: meet competition, price above competition, and price below competition.

Several pricing tactics were discussed. They include new product pricing, price lining, price flexibility, price bundling, and the psychological aspects of pricing.

The chapter concludes with a description of the three alternative approaches to pricing: cost-oriented, demand-oriented, and value-based.

MARKETER'S VOCABULARY

Demand curve Quantity demanded at various price levels.

Nonprice competition Organization uses strategies other than price to attract customers.

Price war Pricing significantly lower than competition.

Penetration pricing Accepting a lower profit margin during the introduction of a product.

Price skimming Price set relatively high to generate a high profit margin.

Price lining Selling a product with several price points.

Quantity discounts Reduction in base price given as the result of a buyer purchasing some predetermined quantity of merchandise.

Seasonal discounts Price discount given on out-of-season merchandise.

Cash discounts Reduction on base price given io customers for paying cash or paying within a short period of time.

Trade discount Price reductions given to middlemen to encourage them to stock and give preferred treatment to an organization's product.

Spiffs Prize money given to retailers to pass on to the retailer's sales personnel for selling eel lain items.

Price bundling Grouping similar complementary products and charging a total price that is lower than if they were sold separately.

Mark-up Difference between the average cost and price of a product.

Break-even price Price that will produce enough revenue to cover all costs at a given level of production.

Value-based pricing What that product is worth to that customer at that point in time.

DISCUSSION QUESTIONS

1. Why is price an important part of the marketing mix?

2. Who typically has responsibility for setting prices in most organizations? Why?

CASE APPLICATION 249

4. What conditions are necessary if a "pricing above the competition" strategy is to be successful?

5. Discuss the alternative strategies that can be adopted in new product pricing. Under what conditions should each be used?

6. List some advantages of psychological pricing. What are some of the risks?

7. What are some of the more common types of discounts and allowances and the purpose of each?

8. What is price lining? What benefits does price lining hold for customers?

9. What advantage might a uniform delivered price have for a seller?

PROJECT

Interview a marketing person responsible for pricing in their organization.

Assess the type of pricing strategy they use and why. Write a three- to five-page report.

CASE APPLICATION

UNITE DTECHTRONICS

United Techtronics faced a major pricing decision with respect to its new video screen television. "We're really excited here at United Techtronics," exclaimed Roy Cowing, founder and president of United Techtronics. "We've made a most significant technological breakthrough in large screen, video television systems." He went on to explain that the marketing plan for this product was now his major area of concern and that what price to charge was the marketing question that was giving him the most difficulty.

Cowing founded United Techtronics (UT) in Boston in 1959. Prior to that time, Cowing had been an associate professor of electrical engineering at M.LT. Cowing founded UT to manufacUlre and market products making use of some of the electronic inventions he had developed while at M.I.T. Dales were made mostly to the space program and the military.

For a number of years, Cowing had been trying to reduce the company's dependency on government sales. One of the diversification projects that he had committed research and development monies to was the so-called video screen project. The objective of this project was to develop a system whereby a television picture could be displayed on a screen as big as eight to ten feet diagonally. One of UT's engineers made the necessary breakthrough and developed working prototypes. Up to that point, UT had invested $600,000 in the project.

Extra-large television systems were not new There were a number of companies who sold such systems both to the consumer and commercial (taverns, restaurants, and so on) markets. Most current systems made use of a special magnifying screen. The result of this process is that the final picture lacked much of the brightness of the original small screen. As a result, the picture had to be viewed in a darkened room. There were some other video systems that did not use the magnifying process. These systems used special tubes, but they also suffered from a lack of brightness.

UT had developed a system that was bright enough to be viewed in regular daylight on a screen up to ten feet diagonally. Cowing was unwilling to discuss how this was accomplished. He would only say that a patent protected the process and that he thought it would take at least two to three years for any competitor to duplicate the results of the system.

A number of large and small companies were active in this area. Admiral, General Electric, RCA, Zenith, and Sony were all thought to be working on developing large-screen systems directed at the consumer market. Sony was rumored to be ready to introduce a 60-inch diagonal screen yys-tern that would retail for about $2,500. A number of small companies were already producing systems. Advent Corporation, a small New England company, claimed to have sold 4,000 84-inch diagonal

250 CHAPTER 9 PRICING THE PRODUCT

REFERENCES

units at prices from $1,500 to $2,500, Cowing was adamant that none of these systems gave as bright a picture as UT's, He estimated that about 10,000 large screen systems were sold in 1996.

Cowing expected about 50% of the suggested retail-selling price to go for wholesaler and retailer margins. He expected that UT's direct manufacturing costs would vary depending on the volume produced. He expected direct labor costs to fall at higher production volumes due to the increased automation of the process and improved worker skiljs.

Material costs were expected to fall due to less waste due to automation. The equipment costs necessary to automate the product process were $70,000 to produce in the 0-5,000 unit range; an additional $50,000 to produce in the 5,001-10,000 unit range; and an additional $40,000 to produce in the 10,001 -20,000 unit range. The useful life of this equipment was put at five years. Cowing was sure that production costs were substantially below those of Current competitors including Sony. Such was the magnitude of UT's technological breakthrough. Cowing was unwilling to produce over 20,000 units a year in the first few years due to the limited cash resources of the company to support inventories and so on.

Cowing wanted to establish a position in the consumer market for his product. He felt that the long-run potential was greater there than in the commercial market. With this end in mind, he hired a small economic research-consulting firm to undertake a consumer study to determine the likely reaction to alternative retail prices for the system. These consultants took extensive pricing histories of competitive products. They concluded that, "UT's video screen system would be highly price-elastic across a range of prices from $500 [0 v-5,000 bOlh in a primary and secondary demand sense." They went on to estimate the price elasticity of demand in this range to be between 4.0 and 6.5.

Mr. Cowing was considering a number of alternative suggested retail prices. "I can see arguments for pricing anywhere from above Advent'?, to substantially below Muntz'i lowest price,' he said. A decision on pricing was needed soon.

Questions:

1. Should penetration pricing be used or would skimming be better?

2. What should be the base price for the new product?

1. Thomas Nagle, "Pricing as Creaiive Marketing," Business Horizons, 3. Bernard F. Whalen, "Strategic Mix of Odd, Even Plices Can Lead to July-August 1923, pp. 14-19. Retail Profits," Marketing NeK'S, March 1976, p. 24.

2. Robell A. Robicheaux, "How Important is Pricing in Competitive 4. Peter Coy, "The Power of Smart Marketing," Business Week, April Strategy?" Proceedings of the Southern hlarketing Association 10,2000, pp. 160-162.

1975, pp. 55-5 7

REFERENCES 251

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CHAPTER

10

CHANNEL CONCEPTS: DISTRIB UTING THE PROD UCT

LEARNING OBJECTIVES

After reading this chapter, you should:

Gain insight into the role of distribution channels.

Understand the methods used in organizing channels.

Understand the management of underlying behavioral dimensions present in most channels.

Comprehend the elements of a channel strategy

Understand the tasks assigned to various channel institutions.

SAM SIGHTINGS ARE EVERYWHERE

W e began this book with some insights on Elvis Presley and related marketing problems. Compared to Sam Walton, Elvis sightings are nonexistent. The spirit of Sam Walton permeates virtually every corner of America. This small-town retailer has produced a legacy of U.S. sales of $1 18 billion, or 1% of all retail sales. In the U.S., Wal-Mart has 1,921 discount stores, 512 supercenters, and 446 Sam's Clubs. Wal-Mart recently challenged local supermarkets by opening their new format: Neighborhood Markets. Overall, they have more than 800,000 people working in more than 3,500 stores On four continents.

Today, Wal-Mart is the largest seller of underwear, soap, toothpaste, children's clothes, books, videos, and compact discs. How can you challenge their Internet offerings that now number more than 500,000, with planned expansion of more than 3,000,000? Or the fact that 01' Roy (named after Sam's Irish setter) is now the best-selling dog food brand in America? Besides 01' Roy, Wal-Mart's garden fertilizer has also become the best-selling brand in the U.S. in its category, as has its Spring Valley line of vitamins.

So how do you beat a behemoth like Wal-Mart? One retail expert tackled this question in his autobiography. He suggests 10 ways to accomplish this goal: (1) have a strong commitment to your business; (2) involve your staff in decision making; (3) listen to your staff and your customers; (4) learn now to communicate; (5) appreciate a good job; (6) have fun; (7) set high goals for staff; (8) promise a lot, but de ; iver more; (9) watch your expenses; and (10) find out what the competition is doing and do something different.

The author of this al'tobiography: Made in America-Sam Walton.

THE DUAL FUNCTIONS OF CHANNELS 253

Sources: Murray Raphel, "Up Againsllhc WaJ-Mart," Direct Marketing, April 1999, pp. 82-84; Adricnnc Sanders, "Yankee Imperialists," Forbes December 13,1999, p. 36; Jack Neff, "Wal-:vlart Stores Go Private (Label)," Advertising Age, November 29,1999, pp. 1,34,36; Alice 7. Cuneo, "WaJ-Mart's Goal: To Reign Over Web," Advertising Age, July 5.1999, pp. 1,27.

INTRODUCTION

This scenario highlights the importance of identifying the mest efficient and effective manner in which to place a product into the hands of the customer. This mechanism of connecting the producer with the customer is referred to as the channel ojdistribution. Earlier we referred to the creation of time and place utility. This is the primary purpose of the channel. It is an extremely complex process, and in the case of many companies, it is tile only element of marketing where cost savings are still possible.

In this chapter, we will look at the evoluLion of the channel of distribution. We shall see that several basic functions have emerged that are typically the responsibility of a channel member. Also, it will become clear that channel selection is not a static, once-and-for-all choice, but that :t is a dynamic part of marketing planning. As was true for the product, the channel must be managed in order to work. Unlike the product, the channel is composed of individuals aad groups that exhibit unique traits that might be in conflict, and that have a constant need to be motivated. These issues will also be addressed. Finally, the institutions or members of the channel will be introduced and discussed.

THE DUAL FUNCTIONS OF CHANNELS

Just as with the other elements of the firm's marketing program, distribution activities are undertaken to facilitate the exchange between marketers and consumers. There are two basic functions performed between the manufacturer and the ultimate consumer, i (See Figure 10.1.) The first, called the exchange junction, involves sales of the product to the various members of the channel of distribution. The second, the physical distribution junction, moves products through the exchange channel, simultaneously with title and ownership. Decisions concerning both of these sets of activities are made in conjunction with the firm's overall marketing plan and are designed so that the firm can best serve its customers in the market place. In actuality, without a channel of distribution the exchange process would be far more difficult and ineffective.

The key role that distribution plays is satisfying a firm's customers and achieving a profit for the firm. From a distribution perspective, customer satisfaction involves maximizing time and place utility to: the organization's suppliers, intermediate customers, and final

EXCHANGE FUNCTION

PRODUCER

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