In some cases, the company may find it desirable to initiate cither a price cut or a price increase. In both cases, it must anticipate possible buyer and competitor reactions.
• Initiating Price Cuts
Several situations may lead a firm to consider cutting its price. One such circumstance is excess capacity. In this case, the firm needs more business and cannot get it through increased sales effort, product improvement or other measures. It may drop its follow-the-leader pricing - charging about the same price as its leading competitor - and aggressively cut prices to boost sales. But as the airline, construction equipment and other industries have learned in recent years, cutting prices in an industry loaded with excess capacity may lead to price wars as competitors try to hold on to market share.
Another situation leading to price changes is falling market share in the face of strong price competition. Several American industries - cars, consumer electronics, cameras, watches and steel, for example - lost market share to Japanese competitors whose high-quality products carried lower prices than did their American counterparts. In response, American companies resorted to more aggressive pricing action. General Motors, for example, cut its subcompact car prices by ]0 per cent on the West ('oast, where Japanese competition was strongest."'
A company may also cut prices in a drive to dominate the market through lower costs. Either the company starts with lower costs than its competitors or it cuts prices in the hope of gaining market share that will further cut costs through larger volume. Bausch & Lomb used an aggressive low-cost, low-price strategy to become an early leader in the competitive soft contact-lens market.
• Initiating Price Increases
In contrast, many companies have had to raise prices in recent years. They do this knowing that the price increases may be resented by customers, dealers and even their own sales force. Yet a successful price increase can greatly increase profits. For example, if the company's profit margin is 3 per cent of sales, a I per cent price increase will increase profits by 33 per cent if sales volume is unaffected.
A considerable factor in price increases is cost inflation. Rising costs squeeze profit margins and lead companies to regular rounds of price increases. Companies often raise their prices by more than the cost increase in anticipation of further inflation. Another factor leading to price increases is overdemand: when a company cannot supply all its customers' needs, it can raise its prices, ration products to customers or both.
Companies can increase their prices in a number of ways to keep up with rising costs. Prices can be raised almost invisibly by dropping discounts and adding higher-priced units to the line. Or prices can be pushed up openly. In passing price increases on to customers, the company should avoid the image of price gouging. The price increases should be supported with a company communication programme telling customers why prices are being increased. The company sales force should help customers find ways to economize.
Where possible, the company should consider ways to meet higher costs or demand without raising prices. For example, it can shrink the product instead of raising the price, as confectionery manufacturers do. Or it can substitute less expensive ingredients or remove certain product features, packaging or services. Or it can 'unbundle' its products and services, removing and separately pricing elements that were formerly part of the offer. IBM, for example, now offers training and consulting as separately priced services.
• Buyer Reactions to Price Changes
Whether the price is raised or lowered, the action will affect buyers, competitors, distributors and suppliers, and may interest government as well. Customers do not always interpret prices in a straightforward way. They may view a price cut in several ways. For example, what would you think if Sony were suddenly to cut its
Buyer reactions to price changes. What ■would you think if the price of Joy was suddenly cut in half?
The costliest perfume in the world.
The costliest perfume in the world.
VCR prices in half? You might think that these VCRs are about to be replaced by newer models or that they have some fault and are not selling well. You might think that Sony is in financial trouble and may not stay in the business long enough to supply future parts. You might believe that quality has been reduced. Or you might think that the price will come down even further and that it will pay to wait and see.
Similarly, a price increase, which would normally lower sales, may have some positive meanings for buyers. What would you think if Sony raised the price of its latest VCR model? On the one hand, you might think that the item is very 'hot' and may be unobtainable unless you buy it soon. Or you might think that tlie recorder is unusually good value. On the other hand, you might think that Sony is greedy and charging what the traffic will bear.
• Competitor Reactions to Price Changes
A firm considering a price change has to worry about the reactions of its competitors as well as its customers. Competitors are most likely to react when the number of
Fighting brands: When challenged on price by store brands and other low-priced entrants, Procter & Gamble turned a number of its brands into fighting brands, including Luvs disposable diapers.
Price reaction programme for meeting a competitor's price cut firms involved is small, when the product; is uniform and when the buyers are well informed.
How can the firm figure out the likely reactions of its competitors? If the firm laees one large competitor and if the competitor tends to react in a set way to priee changes, that reaction can be easily anticipated. Rut if the competitor treats eaeh price change as a fresh challenge and reacts according to its self-interest, the company will have to figure nut just what makes up the competitors self-interest at the time.
The problem is complex because, like the customer, the competitor can interpret a company price cut in many ways. It might think the company is trying to grab a larger market share, that the company is doing poorly and trying to boost its sales or that the company wants the whole industry to cut prices to increase total demand.
When there are several competitors, the company must guess eaeh competitors likely reaction. If all competitors behave alike, this amounts to analyzing only a typical competitor. In contrast, if the competitors do not behave alike - perhaps because of differences in sixe, market shares or policies - then separate analyses are necessary. However, if some competitors will match the priee change, there is good reason to expect that the rest will also match it.
Here we reverse the question and ask how a firm should respond to a price change by a competitor. The firm needs to consider several questions: Why did the competitor change the price? Was it to make more market share, to use excess capacity, to meet changing cost conditions or to lead an industry-wide price change? Is the price change temporary or permanent? What will happen to the company's market share and profits if it does not respond? Are other companies
Excuse Mo, Bui Do You Accept Money?
Cash is out of fashion. Increasingly people pay, for even small transactions, by credit card, debit card or, in many parts of Europe, prepaid smart cards. People are as uninterested in seeing their money as they are the petrol they buy for their car - with a credit card, of course. Money, and the constraints it imposes, will disappear. Because of financial liberalization, the spending of both households and companies is becoming less determined by immediate income or money in the bank than by their expected wealth. Even the resistance of ultra conservative Germany and Marks & Spencer is crumbling; they will liberalize the use of credit and debit cards soon.
People and companies are increasingly turning to trading their skills and produce without using money. Want a plumbing job done? Fred will do it if you will mow his lawn for a week and baby-sit one night. What if the plumber does not want anything you can provide? In that case, clubs exist to trade credits. The plumber does the job for you, but he can use his credits to get goods or services from someone else and you have to work off your debt. These networks are growing so fast that governments are starting to worry about them. They exist outside the tax system, so people pay no VAT or income tax. Maybe that is why people like them so much,
London's Capital Barter Corporation (CBC) orchestrates third-party deals for a pool of 150 companies that offer their services for trade credits rather than cash. CBC's deals range from a £15 restaurant meal to a £15,000 stock of computers. The most popular items are airline tickets, photocopiers and computers. Barter is not just for small deals between small firms - in the United States, Lufthansa, Playtex and US Networks have all had deals worth $2 million or more.
CBC and other barter companies, including The Bartering Company, Business Barter Exchange and Eurotrade, debit and credit their members' accounts in 'trade pounds7. Each member has a credit limit depending upon the size of the com-
Marketing Highlight 17.3
With digital cash zipping across the Internet's 'cyberspace', how can tax inspectors keep tabs on it? E-cash pushes the idea of money to the limit. It has no intrinsic value and hardly a trace of physical existence. Internet is pushing to the limits die question: what makes money worth what it is worth? Two Irish economists, Browne and Fell, see money disappearing altogether. They argue that e-money will replace cash, bonds will replace the money market, and a standard of value will be established in which prices are divorced from the means of payment. Values, they say, will ultimately be measured with a unit of account defined for a basket of goods. Maybe the Mars Bar will become the ultimate unit of currency because it contains a very representative balance of commodities and manufacture.
Sources: Nei! Buckley, 'M & S close to accepting debit card payments j Financial Times (29 August 1994), p. 6; Mo [ok a Rich, 'Abracadabra! It's [he barter magicians', Financial Times (1-2 October 1994), p. 4: Michael Lmdemann, 'Germany flexible at last on credit cards', Financial Times (i I November 1994), p. 3; Samuel Britten, 'Post-money world on our doorstep', Financial Times (17 November 1994), p, 20; find 'Electric money: so much for the cashless society'. Tine Economist (26 November 1994)
going to respondV What are the competitor's and other firms' responses to each possible reaction likely to be?
Besides these issues, the company must make a broader analysis. It has to consider its own product's stage in the life cycle, its importance in the company's product mix, the intentions and resources of the competitor and the possible consumer reactions to price changes. The company cannot always make an extended analysis of its alternatives at the time of a price change, however. The competitor may have spent much time preparing this decision, but the company may have to react within hours or days. About the only way to cut down reaction time is to plan ahead for both possible price changes and possible responses by the competitor.
Figure 17.2 shows the ways that a company might assess and respond to a competitor's price cut. Once the company has determined that the competitor has out its price and that this price reduction is likely to harm company sales and profits, it might simply decide to hold its current price and profit margin. The company might believe that it will not lose too much market share or that it would lose too much profit if it reduced its own price. It might decide that it should wait and respond when it has more information on the effects of the competitor's price change. For now, it might be willing to hold on to good customers, while giving up the poorer ones to the competitor. The argument against this holding strategy, however, is that the competitor may get stronger and more confident as its sales increase and the company might wait too long to act.
If the company decides that effective action can and should be taken, it might make any of the four responses:
1. Reduce price. The leader might drop its price to the competitor's price. It may decide that the market is price sensitive and that it would lose too much market share to the lower-priced competitor. Or it might worry that recapturing lost market share later would be too hard. Cutting price will reduce the company's profits in the short run. Some companies might also reduce their product quality, services and marketing communications to retain profit margins, but this ultimately will hurt long-run market share. The company should try to maintain its quality ;is it cuts prices.
2. Raise perceived quality. The company might maintain its price but strengthen the perceived value of its offer. It could improve its communications, stressing the relative quality of its product over that of the lower-price competitor. The firm may find it cheaper to maintain price and spend money to improve its perceived quality than to out price and operate at a lower margin.
3. Improve quality and increase price. The company might increase quality and raise its price, moving its brand into a higher price position. The higher quality justifies the higher price, which in turn preserves the company's higher margins. Or the company can hold price on the current product and introduce a new brand at a higher price position.
4. Launch low-price fighting brand'. One of the best responses is to add lower-price items to the line or to create a separate lower-price brand. This is necessary if the particular market segment being lost is price sensitive and will not respond to arguments of higher quality. Thus, when attacked on price by Fuji, Kodak introduced low-priced Fun time film. When challenged on priee by store brands and other low-priced entrants, Nestle turned a number of its brands into fighting brands, including Fussell's condensed milk. In response to priee pressures, Miller cut the price of its High Life brand by 20 per cent in most markets and sales jumped 9 per cent in less than a year.17
Pricing strategies and tactics form an important element of a company's marketing mix. In setting prices, companies must carefully consider a great many internal and external factors before choosing a price that will give them the greatest competitive advantage in selected target markets. However, companies are not usually free to charge whatever prices they wish. Several laws restrict pricing practices and a number of ethical considerations affect pricing decisions. Pricing strategies and tactics also depend upon the way that we pay for things. Increasingly what we spend does not depend on how much money we have on us or how much we earned that week. These days our money is rarely something we sec or feel; it is the electronic transmission of data between files. Also, as currency is becoming an increasingly small part of our lives, barter is coming back in international and interpersonal dealing. Marketing Highlight 17,3 tells more about how money is changing.
Pricing is a dynamic process. Companies design a pricing structure that covers all their products. They change this structure over time and adjust it to account for different customers and situations.
Pricing strategies usually change as a product passes through its life cycle. The company can decide on one of several price-quality strategies lor introducing an imitative product. In pricing innovative new products, it can follow a skimming policy by initially setting high prices to 'skim' the maximum amount of revenue from various segments of the market. Or it can use penetration pricing by setting a low initial price to win a large market share.
When the product is part of a product mix, the firm searches for a set of prices that will maximize the profits from the total mix. The company decides on price steps for items in its product line and on the pricing of optional products, captive products, by-products and product bundles.
Companies apply a variety of price-adjustment strategies to account for differences in consumer segments and situations. One is discount and allowancl pricing, whereby the company establishes cash discounts, quantity discounts, functional discounts, seasonal discounts and allowances. A second, is segmented pricing, whereby die company sets different prices for different customers, product forms, places or times. A third is psychological pricing, whereby the company adjusts the price to communicate better a product's intended position. A fourth is promotional pricing, whereby the company decides on loss-leader pricing, special-event pricing and psychological discounting. A fifth is value pricing, whereby the company offers just the right combination of quality and good service at a fair price. A sixth is geographical pricing, whereby the company decides how to price to distant customers, choosing from such alternatives as FOB pricing, uniform delivered pricing, zone pricing, hasing-point pricing and freight-absorption pricing. A seventh is international pricing, whereby the company adjusts its price to meet different conditions and expectations in different world markets.
When a firm considers initiating a price change, it must consider customers' and competitors' reactions. Customers' reactions are influenced by the meaning that customers see in the price change. Competitors' reactions flow from a set reaction policy or a fresh analysis of each situation. The firm initiating the price change must also anticipate the probable reactions of suppliers, intermediaries and government.
The firm that faces a price change initiated by a competitor must try to understand the competitor's intent as well as the likely duration and impact of the change. If a swift reaction is desirable, the firm should preplan its reactions to different possible price actions by competitors. When facing a competitor's price change, the company might sit tight, reduce its own price, raise perceived quality, improve quality and raise price, or launch a fighting brand.
Basing-point pricing 732 By-prodtict pricing 724 By-products 724 Captive-product pricing 723 Gash discount 725 FOB-origin pricing 732 Freight-absorption pricing 733 Functional discount (trade discount)
Market-penetration pricing 721 Market-ski mining pricing 720 Optional-product pricing 723 Product-bundle pricing 724 Product line pricing 722 Promotional allowance 726 Promotional pricing 728 Psychological pricing 727 Quantity discount 725 Quantity premium 726
Reference prices 728 Seasonal discount 726 Segmented pricing 727 Strapline 720 Trade-in allowance 726 Two-part pricing 724 Uniform delivered pricing 732 Value pricing 729 Zone pricing 732
Geographical pricing 732
Describe which strategy - market skimming or market penetration - is appropriate for the following products: (a) Procter & Gamble's new Ariel Future laundry detergent; (b) Reebok's latest, 'new-tech' aerobics shoes; (e) an American Diner that has recently opened a restaurant right opposite McDonald's in the city's shopping centre. Why arc these the right strategies lor these companies?
American Express offers three tiers of 'product' to customers - a green card, a gold card and a platinum card. The membership fee (price) rises from £100 for ., the green card to £200 for the gold and £300 for the platinum. What pricing strategy is adopted by AmEx? Do you think this type of strategy is effective? Why or why not?
3, A leading brand of room spray is priced at S2.50 for a 150 ml bottle. A elose competitor launched ;i similar product prieed at £1.99 for 300 ml and quickly became the no. 1 brand. Discuss the psychological aspects of this pricing. What sort of company image do you think the competitor possesses to allow the use of this superb-value strategy? Would a similar strategy work for the leading no. 1 brand? Why or why not?
4. The formula for household chlorine bleaching agents is virtually identical for all brands. One brand, Clorox, charges a premium price for this same product, yet remains an unchallenged market leader in some national markets. What docs this imply about the value of a brand name? Arc there ethical issues involved in this type of pricing?
Manufacturers of clothing, confectionery, crockery ;ind other consumer products arc often faced with 'byproducts' - such as reject goods that are not quite perfect and fail to meet the high standards of retailers and consumers. There is, however, a market for such 'rejects'. What strategy should be used for pricing these products?
A Bodum coffee percolator sells for under £20 in a department store in London. The same device is prieed at ^80 in Tang's, a local department store in Singapore. What do you think accounts for the discrepancy in price? Can you list other products or services that would reflect a similar international pricing pattern?
Go to your local supermarket or a grocery store you regularly shop at. Take a few product categories. Observe the sizes and prices within product categories. Are the package sizes (weight or number of units contained) comparable across brands? Find instances where a manufacturer seems to have made a smaller package in order to charge (a) a lower price and (b) a higher price. Arc there any instances where
(a) a higher price is charged for larger packages and
(b) ;i discount is given on larger packages? Why do you think manufacturers adopt these pricing strategics? Do they appear effective? L'nder what circumstances are they effective?
You are probably familiar with the seasonal sales that take place at certain times of the year. Examples are the »summer sales', 'Christmas sales' and 'New Year sales'. Why do retailers run these sales each year? Would it be more effective for a retailer to differentiate from others by offering discounts outside, rather than during, the conventional seasonal sales periods? Why or why not? In general, how effective are discount and allowance pricing Strategies?
Torn Rubython, 'A roll ol the orange dice', Buaines&Age (July 1994). pp. 56-8; Anil Bhoyrul, Boom to $Qom',B%t$ine$sAi>e (November 1994), pp. 4I5-6B; Alan Cane, 'Santa receives a call for rapid growth'. Financial Times (22 November 1994), p. 28; Alison Smith, 'Talk is cheap as handsels appear', Financial Times (24 November 1997), p. IS. lfor a comprehensive discussion of pricing strategies, see Thomas T. Nagle ami Heed K. Ilolen, The Strategy and Tactics of tricing, 2nd edn (Englcwood Cliffs, XJ: Prentice Hall, 1995),
John Parry, 'Times arc changing for Tafj-IIcuer', The European (11-17 November 1994), p. 32; Ian Eraser, 'Don't crack under the pressure', European Business (June 1994). pp. 66-8.
Bridget Williams, The Heat Butter in the World: A history of fiainsbury's (London: Ebury. 1994). David Kirkpa trick, 'Intel goes for broke', Fortune (lo May I'J94), pp. 62-8; Andy Keinhardt, 'Pentium: the next generation1, Business Week (12 May 1997). pp. 42-3; David Kirkpatrieli. 'Intel's amazing profit machine', Fortune (17 February 1996), pp. 60-72.
6. Daniel Green, 'Yogurt may yield fiit profit', Firumcial Times (9 January 1998), p. 16; Anna-.Maija Tanttu, 'Spreading the benefits of science'. The European Magazine (17 April 1997), pp 10-11.
7. Ralph Atkins, 'A certain lack «J' drive', Financial Times (25 November 1994), p. IS.
8. Gregory Visousi, 'Merloni makes a clean break for eastern markets', '/Vie European (25 November 1994), p. 21; 'Britain's music business: the sound barrier', The Economist (15May 1993), p. 103.
9. Susan Krafft, 'Love, Love Me Doo', American Demographies (June 1994), pp. 15-16.
10. Na~le and Holdeu, op ok., pp. 225-N; Manjit S. Yadav and Kent B. Monroe, 'How buyers perceive savings in a bundle price: an examination ot a bundle's transaction value'.
Journal of Marketing Research (August 1993), pp 350-8.
11. S.M. \ViJrieh, 'Measurement of incidence of quantity surcharge among sclceted grocery products', Journal of Consumer Affairs (Summer 1979); Yior£os Zotos and Steven Ly.sonski, 'An exploration of the quantity surcharge concept in Greece', Kurojiean Journal ofMarketing, 27, 10 (1993), pp. 5-18.
12 Gary M. Eriekson and Johnny K. Johansson, The role of price in multi-attribute product evaluations', Journal «f Consumer Research (September 1985), pp. 195-9
13. For more reading on reference prices and psychological pricing, see Nagle and Holden, op. eit., p. 12; K.N. Kajendran and Gerard J. TelJis, 'Contextual and temporal components of reference price', Journal ofMarketing (January 1994). pp. 22-34; Richard A. Briesch, Lakshman Krishnamunhi, Tridib Mazunukir and S. P. Raj. 'A comparative analysis of reference price models'. Journal of dortsurneir Research (September 1997), pp. 202-14; John Huston and Nipofi Kamdar, '#9.99: can 'just-below pricing he reconciled with rationality?', Eastern Economic Journal (Spring 1996), pp. 137-45; Robert M. Schindler and Patrick N. Kirby, 'Patterns of rightmost digits used in advertised prices: implications lor nine-
ending effects'. Journal of Consumer Keneunih (September 1997), pp. 192-201.
14. Jim Morgan, 'Value added: from cliche to the real thing', Purchasing (3 April 1997), pp. 59-61; James E. Ellis, 'There's even a science to selling boxes'. Business Week (3 August 1992), pp. 51-2; Erika Rasmusson, 'The pitfalls of priee cutting', Sales and Marketing Management (May 1997), p. 17.
15 Philip R. Cateora, International Marketing, 7th edn (Homewood, 1L: Irwin, 1990), p. 540; see also 8. Tamer Cavusgil, 'Pricing for global markets", Columbia Journal of World Business (Winter 1996), pp. 66-78.
16. For more on price cutting and its consequences, see Kathleen Madigan, 'The latest mad plunge of the price .slashers', Business Week (11 May 1992), p. 36; Bill Saporito, 'Why the price wars never end'. Fortune (23 March 1992), pp. 6^-78; Erika Kasniusson, 'The piti'alks of price cutting', Sales and Marketing Management (May 1997), p. 17; David R. Henderson, 'What are price wars £ood for? Absolutely nothing', Fortune (12 May 1997), p. 156.
17. Jonathan Berry and Zaehary Schiller, 'Attack of the fighting brands', Business Weak (2 May 1994), p. 125.
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Co-op Mailing means that two or more businesses share in the cost and distribution of a direct mail campaign. It's kind of like having you and another non-competing business split the cost of printing, assembling and mailing an advertising flyer to a shared same market base.