Prices can be easily changed and easily matched by your competitors. Consequently, your product’s price alone might not provide your company with a sustainable competitive advantage. Nonetheless, prices can attract consumers to different retailers, and can attract businesses to different suppliers.
Organizations must remember that the prices they charge should be consistent with their offerings, promotions, and distribution strategies. In other words, it wouldn’t make sense for an organization to promote a high-end, prestige product, make it available in only a limited number of stores, and then sell it for an extremely low price. The price, product, promotion (communication), and placement (distribution) of a good or service should convey a consistent image.
In this section we will examine the four internal factors that impact the pricing decision: Company Objectives, Pricing Objectives, Costs, and the Marketing Mix.
All decisions made within a strategy need to be consistent with the company’s mission, values, and objectives. For example, if the company values being regarded as the leader in their industry in terms of innovation, service, and functional quality, a decision to focus on the lowest price possible would be incongruent with the organization’s objectives.
The pricing strategy can accomplish multiple objectives and it is common to have more than one objective. Different firms want to accomplish different things with their pricing strategies. For example, one firm may want to capture market share, another may be solely focused on maximizing its profits, and another may want to be perceived as having products with prestige.
Earning a targeted ROI
ROI, or return on investment, is the amount of profit an organization hopes to make given the amount of assets, or money, it has tied up in a product. ROI is a common pricing objective for many firms. Companies typically set a certain percentage, such as 10 percent, for ROI in a product’s first year following its launch. So, for example, if a company has $100,000 invested in a product and is expecting a 10 percent ROI, it would want the product’s profit to be $10,000.
Many companies set their prices to increase their revenues as much as possible relative to their costs. However, large revenues do not necessarily translate into higher profits. To maximize its profits, a company must also focus on cutting costs or implementing programs to encourage customer loyalty.
In weak economic markets, many companies manage to cut costs and increase their profits, even though their sales are lower. How do they do this? The Gap cut costs by doing a better job of controlling its inventory. The retailer also reduced its real estate holdings to increase its profits when its sales were down during the latest economic recession. Other firms such as Dell, Inc., cut jobs to increase their profits. Meanwhile, Walmart tried to lower its prices so as to undercut its competitors’ prices to attract more customers. After it discovered that wealthier consumers who didn’t usually shop at Walmart before the recession were frequenting its stores, Walmart decided to upgrade some of its offerings, improve the checkout process, and improve the appearance of some of its stores to keep these high-end customers happy and enlarge its customer base. The strategy worked, for a little while. Other firms increased their prices or cut back on their marketing and advertising expenses. A firm has to remember, however, that prices signal value. If consumers do not perceive that a product has a high degree of value, they probably will not pay a high price for it. Furthermore, cutting costs cannot be a long-term strategy if a company wants to maintain its image and position in the marketplace.
Maximizing sales involves pricing products to generate as much revenue as possible, regardless of what it does to a firm’s profits. When companies are struggling financially, they sometimes try to generate cash quickly to pay their debts. They do so by selling off inventory or cutting prices temporarily. Such cash may be necessary to pay short-term bills, such as payroll. Maximizing sales is typically a short-term objective since profitability is not considered.
Maximizing Market Share
Some organizations try to set their prices in a way that allows them to capture a larger share of the sales in their industries. Capturing more market share doesn’t necessarily mean a firm will earn higher profits, though. Nonetheless, many companies believe capturing a maximum amount of market share is downright necessary for their survival. In other words, they believe if they remain a small competitor they will fail. Firms in the cellular phone industry are an example. The race to be the biggest cell phone provider has hurt companies like Motorola. Motorola holds only 10 percent of the cell phone market, and its profits on their product lines are negative.
How will buyers respond? Three important factors are whether the buyers perceive the product offers value, how many buyers there are, and how sensitive they are to changes in price. In addition to gathering data on the size of markets, companies must try to determine how price sensitive customers are. Will customers buy the product, given its price? Or will they believe the value is not equal to the cost and choose an alternative or decide they can do without the product or service? Equally important is how much buyers are willing to pay for the offering. Figuring out how consumers will respond to prices involves judgment as well as research. This will be discussed later in this chapter in more detail. However, it’s important to note that the price sends messages to the consumer regarding the quality and/or value of a product.
How competitors price and sell their products will have an impact on a firm’s pricing decisions. If you wanted to buy a certain pair of shoes, but the price was 30 percent less at one store than another, what would you do? Because companies want to establish and maintain loyal customers, they will often match their competitors’ prices. Some retailers, such as Home Depot, will give you an extra discount if you find the same product for less somewhere else. Similarly, if one company offers you free shipping, you might discover other companies will, too. With so many products sold online, consumers can compare the prices of many merchants before making a purchase decision.
The availability of substitute products affects a company’s pricing decisions as well. If you can find a similar pair of shoes selling for 50 percent less at a third store, would you buy them? There’s a good chance you might.
Maintaining the Status Quo
Sometimes a firm’s objective may be to maintain the status quo or simply meet, or equal, its competitors’ prices or keep its current prices. Airline companies are a good example. Have you ever noticed that when one airline raises or lowers its prices, the others all do the same? If consumers don’t accept an airline’s increased prices (and extra fees) such as the charge for checking in with a representative at the airport rather than checking in online, other airlines may decide not to implement the extra charge and the airline charging the fee may drop it. Companies, of course, monitor their competitors’ prices closely when they adopt a status quo pricing objective.
Having a pricing objective is the starting point in choosing how to price an organization’s offering. Once the objective is set, an organization still needs to consider at a myriad of other factors before setting its prices.
The costs of the product—its inputs—including the amount spent on product development, testing, and packaging, have to be taken into account when a pricing decision is made. So do the costs related to promotion and distribution. For example, when a new offering is launched, its promotion costs can be very high because people need to be made aware that this product now exists. Thus, the offering’s stage in the product life cycle can affect its price. Keep in mind that a product may be in a different stage of its life cycle in other markets. For example, while sales of the iPhone remain fairly constant in the United States, the Koreans felt the phone was not as good as their current phones and was somewhat obsolete. Similarly, if a company has to open brick-and-mortar storefronts to distribute and sell the offering, this too will have to be built into the price the firm must charge for it.
The point at which total costs equal total revenue is known as the breakeven point (BEP). For a company to be profitable, a company’s revenue must be greater than its total costs. If total costs exceed total revenue, the company suffers a loss.
Total costs include both fixed costs and variable costs. Fixed costs, or overhead expenses, are costs that a company must pay regardless of its level of production or level of sales. A company’s fixed costs include items such as rent, leasing fees for equipment, contracted advertising costs, and insurance. As a student, you may also incur fixed costs such as the rent you pay for an apartment. You must pay your rent whether you stay there for the weekend or not. Variable costs are costs that change with a company’s level of production and sales. Raw materials, labor, and commissions on units sold are examples of variable costs. You, too, have variable costs, such as the cost of gasoline for your car or your utility bills, which vary depending on how much you use.
The Marketing Mix
Congruency is an important component of any marketing strategy. Thus, when determining a price, the product, the packaging, where/how the product will be sold, and the promotional messaging need to be considered. If the product is of high quality, for example, a low price will send a mixed message to the customer. Customers do not buy when they receive mixed messages.