Pricing Strategy Im

POLYTECHNIC UNIVERSITY
OF THE PHILIPPINES
Department of Marketing Management
College of Business Administration
Main Campus
MARK 30043
Pricing Strategy
Compiled by:
Asst. Prof. Estelita E. Medina
Pricing Strategy
MARK 30043
Compiled by:
Asst. Prof. Estelita E. Medina
ALL RIGHTS RESERVED. No part of this learning module may be reproduced,

used in any form, or by any means graphic, electronic, or mechanical, including
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The VMPGO
VISION
PUP: The National Polytechnic University
MISSION
Ensuring inclusive and equitable quality education and promoting lifelong learning
opportunities through a re-engineered polytechnic university by committing to:
• provide democratized access to educational opportunities for the holistic development of
individuals with a global perspective.
• offer industry-oriented curricula that produce highly skilled professionals with managerial
and technical capabilities and a strong sense of public service for nation-building.
• embed a culture of research and innovation.
• continuously develop faculty and employees with the highest level of professionalism.
• engage public and private institutions and other stakeholders for the attainment of social
development goals.
• establish a strong presence and impact in the international academic community.
PHILOSOPHY
As a state university, the Polytechnic University of the Philippines believes that:
• Education is an instrument for the development of the citizenry and for the enhancement
of nation-building; and,
• That meaningful growth and transformation of the country are best achieved in an
atmosphere of brotherhood, peace, freedom, justice and nationalist-oriented education
imbued with the spirit of humanist internationalism.
SHARED VALUES AND PRINCIPLES

1. Integrity and Accountability
2. Nationalism
3. Sense of Service
4. Passion for Learning and Innovation
5. Inclusivity
6. Respect for Human Rights and the Environment
7. Excellence
8. Democracy
GOALS OF THE COLLEGE/CAMPUS
1. Educate future leaders and community builders through activities that improve business
practices through experiential learning opportunities and strategic partnerships.
2. Provide undergraduate and graduate programs that will equip students to become
successful business professionals in an increasingly challenging and diverse business
environment grounded in academic excellence, knowledge creation, quality, integrity,
accountability, innovative programs and ideas, and commitment to foster lifelong learning.
3. Provide high-quality, innovative instruction on business administration in a supportive
environment that encompasses exemplary teaching, experiential learning, external
engagement, and impactful action-oriented, relevant, and responsive research.
4. Deliver industry-responsive curricula tailor-fitted to the needs of the industry.
5. Strengthen industry-academe-government partnerships; linkages and alliances with
national and international institutions to continuously adopt best practices, advanced
technologies and strategies enabling the college to produce future-proof graduates
resilient to fast-paced business environment.
COURSE DESCRIPTION
This course will draw students to understand the price of a value exchanged for products
and services, for particular brands, substitutes, store brands, and alternatives. Companies today
face a fast-changing pricing environment. Value-seeking customers have put increased pricing
pressure on many companies. The course points out the importance of pricing strategy to the
business and how it affects the consumers. It discusses the objectives, theories, strategies, and
policies.
INSTITUTIONAL LEARNING OUTCOMES (ILOS)
As a polytechnic state university, PUP shall develop its students to possess:
1. Critical and Creative Thinking. Graduates use their rational and reflective thinking as
well as innovative abilities to life situations in order to push boundaries, realize possibilities,
and deepen their interdisciplinary, multidisciplinary, and/or transdisciplinary understanding
of the world.
2. Effective Communication. Graduates apply the four macro skills in communication

(reading, writing, listening, and speaking), through conventional and digital means, and are
able to use these skills in solving problems, making decisions, and articulating thoughts
when engaging with people in various circumstances.
3. Strong Service Orientation. Graduates exemplify strong commitment to service

excellence for the people, the clientele, industry and other sectors.
4. Adept and Responsible Use or Development of Technology. Graduates demonstrate

optimized and responsible use of state-of-the-art technologies of their profession. They
possess digital learning abilities, including technical, numerical, and/or technopreneurial
skills.
5. Passion for Lifelong Learning. Graduates perform and function in society by taking
responsibility in their quest for further improvement through lifelong learning.
6. Leadership and Organizational Skills. Graduates assume leadership roles and

become leading professionals in their respective disciplines by equipping them with
appropriate organizational skills.
7. Personal and Professional Ethics. Graduates manifest integrity and adherence to

moral and ethical principles in their personal and professional circumstances.
8. Resilience and Agility. Graduates demonstrate flexibility and the growth mindset to
adapt and thrive in the volatile, uncertain, complex and ambiguous (VUCA) environment.
9. National and Global Responsiveness. Graduates exhibit a deep sense of nationalism as

it complements the need to live as part of the global community where diversity is
respected. They promote and fulfill various advocacies for human and social development.
PROGRAM LEARNING OUTCOMES (PLOS)
1. Demonstrate the capability to articulate and implement marketing theories and concepts in
professional and personal settings, locally and abroad.
2. Communicate effectively through oral, written, and digital means marketing ideas anchored
on ethical standards.
3. Utilize research tools and results in analyzing the business environment and development
of marketing plans and strategies to address market needs and contribute to nation
development.
4. Display leadership skills and the capability to work independently and with groups.
5. Demonstrate adaptability and willingness to continuously learn from colleagues, industry,
markets, and other relevant sectors.
6. Conduct business research responsive to the market environment.
COURSE LEARNING OUTCOMES (CLOS).
At the end of this course, the students are expected to:
1. Understand the key economic, analytical, and behavioral concepts associated with costs,
customer behavior, and competition.
2. Understand the nature of price and be able to apply pricing strategies and techniques
in various market conditions.
3. Comprehend and have a clear understanding of pricing strategies of different products,
lifecycles, and companies.
4. Understand and analyze price strategies of competitors in indifferent market situations
through case study scenarios.
5. Appreciate and uphold the policies of pricing in the Philippine market and context.
Introduction
This instructional material seeks to facilitate understanding of the whole picture of pricing
strategy, see how the correct management of prices significantly impacts the definite difference
in the firms' or organizations' revenues and income; and appreciate the management of prices as
a way of getting a comprehensive understanding of cost and consumers. A description of what
the following topics include will be broad and the key ideas related to pricing will also be mentioned
in the following topics.
Much of pricing's definition and the variety of objectives is integrated in topic 1 to 5, major
pricing strategies, pricing strategies for new products, pricing mix strategies, and lastly, price
adjustment strategies.
Topics 6 to 11 looks into pricing under different market conditions, the social and legal
aspects, customers' perception on price, a briefing of the core issues concerning launch and
defense of price changes, limitations that prevent ranges of prices that a firm can offer and also
introduces the arguments on transfer pricing as well as compete bid pricing.
In light of the learning-teaching activities that are proposed in this course, the students are
required to provide answers to all the activities/ assessments at the end of each topic.
TABLE OF CONTENTS
Title Page
The VMPGO 2
Introduction 6
Table of Contents 7
UNIT I
Lesson 1 – Introduction to Price 11
a. Introduction
b. Learning Objectives/Outcomes 6
c. Presentation/Discussion of the Lesson 6
d. Link to Video Lesson
e. Activity
Lesson 2 – Pricing Strategies 32
a. Introduction
e. Activity 16
Lesson 3 – New Product Pricing Strategies 46
a. Introduction
b. Learning Objectives/Outcomes
c. Presentation/Discussion of the Lesson
e. Activity
Lesson 4 – Product Mix Pricing Strategies 55
a. Introduction
e. Activity 27
35
36
Lesson 5 – Price Adjustment Strategies 60
a. Introduction
e. Activity 59
Lesson 6 – Pricing Under Various Market Condition 71
a. Introduction
e. Activity 72
Lesson 7 – Public Policy and Marketing 77
a. Introduction
e. Activity 8
Lesson 8 – Determining Demand – Customer Perception of Price 84
a. Introduction 10
d. Link to Video Lesson 10
e. Activity 1
Lesson 9 – Price Changes 92
a. Introduction 10
e. Activity 12
Lesson 10 – Identifying Pricing Constraints 98
a. Introduction 10
e. Activity 12
Lesson 11 – Legacy of Pricing Policies 105
a. Introduction 10
e. Activity 12
Reference List 130

COURSE OUTCOMES
At the end of the semester, the student will be able to:
• Understand the nature of price and pricing strategy.
• Gain insights on pricing under various market conditions.
• Appreciate the policies of pricing in our economic development.
• Uphold Filipino values in the practice of marketing.

TOPIC 1 – INTRODUCTION TO PRICE
OVERVIEW
The price paid for products and services goes by many names. You pay tuition for your
education, rent for an apartment, interest on a bank credit card, and a premium for car
insurance. Your dentist or physician charges you a fee, professional or social organization
charges dues, and airlines charge a fare. In business, an executive is given a salary, a
salesperson receives a commission, and a worker is paid a wage. And what you pay for
clothes, or a haircut is termed a price.
Among all marketing and operations factors in a business firm, price has a unique role. It
is the place where all other business decisions come together. The price must be right in the
sense that customers must be willing to pay it; it must generate enough sales dollars to pay
for the cost of developing, producing, and marketing the product; and it must earn a profit for
the company. Small changes in price can have big effects on both the number of units sold
and company profit.
LEARNING OUTCOMES
After successful completion of this module, you should be able to:
• Discuss and explain the concept of price, the importance of pricing in today ‘s
fast- changing environment.
• Recognize the objectives a firm has in setting prices.
• Identify and explain the pricing process.
COURSE MATERIALS
TOPIC 1 – INTRODUCTION TO PRICE

• Definition of Price
• Pricing Objectives
• Pricing Process
DEFINITION OF PRICE
All products and services have a price, just as they have a value. Many non-profit and
all profit-making organizations must also set prices. Price is the amount of money charged for
a product or a service. More broadly, price is the sum of all the values that customers give up
gaining the benefits of having or using a product or service. Historically, price has been the
major factor affecting buyer choice. In recent decades, non-price factors have gained
increasing importance. However, price still remains one of the most important elements that
determine a firm‘s market share and profitability.
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 marketing mix elements. Unlike product
features and channel commitments, prices can be changed quickly. At the same time, pricing
is the number-one problem facing many marketing executives, and many companies do not
handle pricing well. Some managers view pricing as a big headache, preferring instead to focus
on other marketing mix elements.
However, smart managers treat pricing as a key strategic tool for creating and capturing
customer value. Prices have a direct impact on a firm‘s bottom line. A small percentage
improvement in price can generate a large percentage increase in profitability. More
importantly, as part of a company‘s overall value proposition, price plays a key role in creating
customer value and building customer relationships
The Price Equation
For most products, money is exchanged. However, the amount paid is not always the
same as the list, or quoted, price because of discounts, allowances, and extra fees. One new
21st century pricing tactic involves using ―special fees and ―surcharges. This practice is
driven by consumers zeal for low prices combined with the ease of making price comparisons
on the Internet. Buyers are more willing to pay extra fees than a higher list price, so sellers
use add -on charges as a way of having the consumer pay more without raising the list price.
All the factors that increase or decrease the final price of an offering help construct a price
equation, which is shown for a few products in Figure 1.1.
Figure 1.1 Price Equation
The price a buyer pays can take different names depending on what is purchased,
and it can change depending on the price equation.
Price as an Indicator of Value
From a consumer‘s standpoint, price is often used to indicate value when it is compared
with perceived benefits such as the quality or durability of a product or service. Specifically,
value is the ratio of perceived benefits to price, or
Value = Perceived benefits

Price
This relationship shows that for a given price, as perceived benefits increase, value
increases. For example, if you‘re used to paying $7.99 for a medium frozen cheese pizza,
wouldn‘t a large one at the same price be more valuable? Conversely, for a given price, value
decreases when perceived benefits decrease.
Using Value Pricing: Creative marketers engage in value pricing, the practice of
simultaneously increasing product and service benefits while maintaining or decreasing price.
For some products, price influences consumers perception of overall quality and ultimately its
value to them. In a survey of home furnishing buyers, 84 percent agreed with the statement:
The higher the price, the higher the quality. In this context, value involves the judgment
by a consumer of the worth of a product relative to substitutes that satisfy the same need.
Through the process of comparing the costs and benefits of substitute items, a reference value
emerges.
Price in the Marketing Mix
Pricing is a critical decision made by a marketing executive because price has a direct
effect on a firm‘s profits. Profit equation is the profit equals total revenue minus total cost.
This is apparent from a firm‘s profit equation, where:
Profit = Total revenue - Total cost

= (Unit price × Quantity sold) - (Fixed cost + Variable cost)
What makes this relationship even more complicated is that price affects the quantity
sold, as illustrated with demand curves later in this chapter. Furthermore, since the quantity sold
usually affects a firm‘s costs because of efficiency of production, price also indirectly affects
costs. Thus, pricing decisions influence both total revenue (sales) and total cost, which makes
pricing one of the most important decisions marketing executives faces.
The Importance of Price
Price means one thing to the consumer and something else to the seller. To the
consumer, it is the cost of something. To the seller, price is revenue, the primary source of
profits. In the broadest sense, price allocates resources in a free-market economy. With so
many ways of looking at price, it‘s no wonder that marketing managers find the task of setting
prices a challenge.
The Sacrifice Effect of Price: Price is, again, is given up, which means what is sacrificed
to get a good or service. In the United States, the sacrifice is usually money, but can be other
things as well. It may also be time lost while waiting to acquire the good or service. Standing
in long lines at the airport first to check in and then to get through the security checkpoint
procedures is a cost. In fact, these delays are one reason more people are selecting
alternative modes of transportation for relatively short trips. Price might also include lost dignity
for individuals who lose their jobs and must rely on charity to obtain food and clothing. For a
college student, paying tuition might mean skipping a vacation, buying a less luxurious car, or
waiting longer to buy a first house.
The Information Effect of Price: Consumers do not always choose the lowest priced
product in a category, such as shoes, cars, or wine, even when the products are otherwise
similar. One explanation of this, based upon research, is that we infer quality information from
price. That is, higher quality equals higher price. The information effect of price may also
extend to favorable price perceptions by others because higher prices can convey the
prominence and status of the purchaser to other people.
Value Is Based upon Perceived Satisfaction: Consumers are interested in obtaining a

reasonable price. Reasonable price really means to perceived reasonable value at the time of
the transaction. Remember, the price paid is based on the satisfaction consumers expect to
receive from a product and not necessarily the satisfaction they actually receive. Price can relate
to anything with perceived value, not just money. When goods and services are exchanged, the
trade is called barter. For example, if you exchange this book for a chemistry book at the end of
the term, you have engaged in barter. The price you paid for the chemistry book was this textbook.
The Importance of Price to Marketing Managers
Prices are the key to revenues, which in turn are the key to profits for an organization.
Revenue is the price charged to customers multiplied by the number of units sold. Revenue
is what pays for every activity of the company: production, finance, sales, distribution, and so
on. What‘s left over (if anything) is profit. Managers usually strive to charge a price that will
earn a fair profit.
Price × Units = Revenue
To earn a profit, managers must choose a price that is not too high or too low, a price
that equals the perceived value to target consumers. If, in consumers‘ minds, a price is set
too high, the perceived value will be less than the cost, and sales opportunities will be lost.
Many mainstream purchasers of cars, sporting goods, CDs, tools, wedding gowns, and
computers are buying used or pre-owned items to get a better deal. Pricing a new product too
high may give some shoppers an incentive to go to a pre-owned or consignment retailer. Lost
sales mean lost revenue. Conversely, if a price is too low, the consumer may perceive it as a
great value, but the firm loses the revenue it could have earned.
Trying to set the right price is one of the most stressful and pressure-filled tasks of the
marketing manager, as trends in the consumer market attest.
• Confronting a flood of new products, potential buyers carefully evaluate the price
of each one against the value of existing products.
• The increased availability of bargain-priced private and generic brands has
put downward pressure on overall prices.
• Many firms are trying to maintain or regain their market share by cutting prices.
• The Internet has made comparison shopping easier.
In the organizational market, where customers include both governments and

businesses, buyers are also becoming more price sensitive and better informed.
Computerized information systems enable the organizational buyer to compare price and
performance with great ease and accuracy. Improved communication and the increased use
of direct marketing and computer- aided selling have also opened up many markets to new
competitors. Finally, competition in general is increasing, so some installations, accessories,
and component parts are being marketed as indistinguishable commodities.
PRICING OBJECTIVES
To survive in today‘s highly competitive marketplace, companies need pricing objectives

that are specific, attainable, and measurable. Realistic pricing goals then require continual
monitoring to determine the effectiveness of the company‘s strategy. Pricing objectives can
be divided into three categories: profit oriented, sales oriented, and status quo.
Profit-Oriented Pricing Objectives
Profit-oriented pricing objectives include profit maximization, satisfactory profits, and

target return on investment.
Profit Maximization means setting prices so that total revenue is as large as possible
relative to total costs. Profit maximization does not always signify unreasonably high prices,
however. Both price and profits depend on the type of competitive environment a firm face,
such as whether it is in a monopoly position (being the only seller) or in a much more
competitive situation. Also, remember that a firm cannot charge a price higher than the
product‘s perceived value. Sometimes managers say that their company is trying to maximize
profits—in other words, trying to make as much money as possible. Although this goal may
sound impressive to stockholders, it is not good enough for planning.
In attempting to maximize profits, managers can try to expand revenue by increasing
customer satisfaction, or they can attempt to reduce costs by operating more efficiently. A
third possibility is to attempt to do both. Some companies may focus too much on cost reduction
at the expense of the customer. Lowe‘s lost market share when it cut costs by reducing the
number of associates on the floor. Customer service declined and so did revenue. When firms
rely too heavily on customer service, however, costs tend to rise to unacceptable levels.
United States’ airlines used to serve full meals on two-hour flights and offered pillows
and blankets to tired customers. This proved to be unsustainable. A company can maintain or
slightly cut costs while increasing customer loyalty through customer service initiatives, loyalty
programs, customer relationship management programs, and allocating resources to
programs that are designed to improve efficiency and reduce costs.
Satisfactory profits are a reasonable level of profits. Rather than maximizing profits,
many organizations strive for profits that are satisfactory to the stockholders and
management— in other words, a level of profits consistent with the level of risk an organization
faces. In a risky industry, a satisfactory profit may be thirty-five percent. In a low-risk industry,
it might be seven percent.
Target Return on Investment. The most common profit objective is a target return on
investment (ROI), sometimes called the firm‘s return on total assets. ROI measures
management‘s overall effectiveness in generating profits with the available assets. The higher
the firm‘s ROI, the better off the firm is. Many companies use a target ROI as their main pricing
goal.
In summary, ROI is a percentage that puts a firm‘s profits into perspective by showing
profits relative to investment. A company with a target ROI can predetermine its desired level
of profitability. The marketing manager can use the standard, such as ten percent ROI, to
determine whether a particular price and marketing mix are feasible. In addition, however, the
manager must weigh the risk of a given strategy even if the return is in the acceptable range.
Sales-Oriented Pricing Objectives
Sales-oriented pricing objectives are based on market share as reported in dollar or unit
sales. Firms strive for either market share or to maximize sales.
Market share is a company‘s product sales as a percentage of total sales for that
industry. Sales can be reported in dollars or in units of product. It is very important to know
whether market share is expressed in revenue or units because the results may be different.
Consider four companies competing in an industry with 2,000 total unit sales and total
industry revenue of $4,000 as shown in Table 1.1.
Table 1.1
Two Ways to Measure Market Share (Units and Revenue)
Company A has the largest unit market share at 50 percent, but it has only 25 percent of
the revenue market share. In contrast, Company D has only a 15 percent unit share but the
largest revenue share: 30 percent. Usually, market share is expressed in terms of revenue and
not units.
Many companies believe that maintaining or increasing market share is an indicator of

the effectiveness of their marketing mix. Larger market shares have indeed often meant higher
profits, thanks to greater economies of scale, market power, and the ability to compensate
top-quality management. Conventional wisdom also says that market share and ROI are
strongly related. For the most part they are; however, many companies with low market share
survive and even prosper. To succeed with a low market share, companies often need to
compete in industries with slow growth and few product changes—for instance, industrial
supplies.
Otherwise, they must vie in an industry that makes frequently bought items, such as
consumer convenience goods.
The conventional wisdom about market share and profitability is not always reliable,
however. Because of extreme competition in some industries, many market share leaders
either do not reach their target ROI or actually lose money. Procter & Gamble switched from
market share to ROI objectives after realizing that profits do not automatically follow from a
large market share.
Sales Maximization Rather than strive for market share, sometimes companies try to
maximize sales. A firm with the objective of maximizing sales ignores profits, competition, and
the marketing environment as long as sales are rising. If a company is strapped for funds or
faces an uncertain future, it may try to generate a maximum amount of cash in the short run.
Management‘s task when using this objective is to calculate which price–quantity

relationship generates the greatest cash revenue. Sales maximization can also be effectively
used on a temporary basis to sell off excess inventory. It is not uncommon to find Christmas
cards, ornaments, and other seasonal items discounted at 50 to 70 percent off retail prices
after the holiday season has ended. Maximization of cash should never be a long-run objective
because cash maximization may mean little or no profitability.
Status Quo Pricing Objectives
Status Quo Pricing Objectives seeks to maintain existing prices or to meet the
competition‘s prices. This third category of pricing objectives has the major advantage of
requiring little planning. It is essentially a passive policy. Often, firms competing in an industry
with an established price leader simply meet the competition‘s prices. These industries
typically have fewer price wars than those with direct price competition.
In other cases, managers regularly shop competitors‘ stores to ensure that their prices
are comparable. Status quo pricing often leads to suboptimal pricing. This occurs because the
strategy ignores customers‘ perceived value of both the firm‘s goods or services and those
offered by its competitors. Status quo pricing also ignores demand and costs. Although the
policy is simple to implement, it can lead to a pricing disaster.
PRICING PROCESS
Setting the right price on a product is a four-step process, as illustrated in Figure 1.2.
Figure 1.2
Steps in Setting the Right Price on a Product
Establish Pricing Goals
The first step in setting the right price is to establish pricing goals. Recall that pricing
objectives fall into three categories: profit oriented, sales oriented, and status quo. These
goals are derived from the firm‘s overall objectives. A good understanding of the marketplace
and of the consumer can sometimes tell a manager very quickly whether a goal is realistic.
All pricing objectives have trade-offs that managers must weigh. A profit maximization
objective may require a bigger initial investment than the firm can commit to or wants to
commit to. Reaching the desired market share often means sacrificing short-term profit
because without careful management, long-term profit goals may not be met.
Meeting the competition is the easiest pricing goal to implement. But can managers really
afford to ignore demand and costs, the life cycle stage, and other considerations? When
creating pricing objectives, managers must consider these trade-offs in light of the target
customer, the environment, and the company‘s overall objectives.
Estimate Demand, Costs, and Profits
Total revenue is a function of price and quantity demanded and that quantity demanded
depends on elasticity. Elasticity is a function of the perceived value to the buyer relative to the
price. The types of questions managers consider when conducting marketing research on
demand and elasticity are key. Some questions for market research on demand and elasticity
are:
• What price is so low that consumers would question the product‘s quality?
• What is the highest price at which the product would still be perceived as a bargain?
• What is the price at which the product is starting to be perceived as expensive?
• What is the price at which the product becomes too expensive for the target market?
After establishing pricing goals, managers should estimate total revenue at a variety of
prices. This usually requires marketing research. Next, they should determine corresponding
costs for each price. They are then ready to estimate how much profit, if any, and how much
market share can be earned at each possible price. Managers can study the options in light
of revenues, costs, and profits. In turn, this information can help determine which price can
best meet the firm‘s pricing goals.
Choose a Price Strategy to help determine a Base Price
The basic, long-term pricing framework for a good or service should be a logical
extension of the pricing objectives. The marketing manager‘s chosen price strategy defines
the initial price and gives direction for price movements over the product life cycle. The price
strategy sets a competitive price in a specific market segment based on a well-defined
positioning strategy. Changing a price level from premium to super premium may require a
change in the product itself, the target customers served, the promotional strategy, or the
distribution channels.
A company‘s freedom in pricing a new product and devising a price strategy depends on
the market conditions and the other elements of the marketing mix. If a firm launches a new
item resembling several others already on the market, its pricing freedom will be restricted.
To succeed, the company will probably have to charge a price close to the average market
price. In contrast, a firm that introduces a totally new product with no close substitutes will
have considerable pricing freedom.
Companies that do serious planning when creating a price strategy usually select
from three basic approaches: price skimming, penetration pricing, and status quo pricing
a. Price skimming is sometimes called a ―market plus approach to pricing because it denotes
a high price relative to the prices of competing products. The term price skimming is derived
from the phrase ―skimming the cream off the top. Price skimming is a pricing policy whereby
a firm charges a high introductory price, often coupled with heavy promotion. Companies often
use this strategy for new products when the product is perceived by the target market as
having unique advantages. Often companies will use skimming and then lower prices over
time. This is called “sliding down the demand curve.” Manufacturers sometimes maintain
skimming prices throughout a product‘s life cycle.
Price skimming works best when there is strong demand for a good or service. Apple,
for example, uses skimming when it brings out a new iPhone or Watch. As new models are
unveiled, prices on older versions are normally lowered. Firms can also effectively use price
skimming when a product is well protected legally, when it represents a technological
breakthrough, or when it has in some other way blocked the entry of competitors. Managers
may follow a skimming strategy when production cannot be expanded rapidly because of
technological difficulties, shortages, or constraints imposed by the skill and time required to
produce a product (such as fine china, for example).
A successful skimming strategy enables management to recover its product

development costs quickly. Even if the market perceives an introductory price as too high,
managers can lower the price. Firms often believe it is better to test the market at a high price
and then lower the price if sales are too slow. Successful skimming strategies are not limited
to products. Well-known athletes, lawyers, and celebrity hairstylists are experts at price
skimming. Naturally, a skimming strategy will encourage competitors to enter the market.
Penetration pricing is at the opposite end of the spectrum from skimming. Penetration
pricing means a pricing policy whereby a firm charges a relatively low price for a product when
it is first rolled out as a way to reach the mass market is first rolled out as a way to reach the
mass market. The low price is designed to capture a large share of a substantial market,
resulting in lower production costs. If a marketing manager has made obtaining a large market
share the firm‘s pricing objective, penetration pricing is a logical choice.
Penetration pricing does mean lower profit per unit, however. Therefore, to reach the
break-even point, it requires a higher volume of sales than would a skimming policy. The
recovery of product development costs may be slow. As you might expect, penetration pricing
tends to discourage competition.
A penetration strategy tends to be effective in a price-sensitive market. Price should

decline more rapidly when demand is elastic because the market can be expanded through a
lower price. If a firm has a low fixed cost structure and each sale provides a large contribution
to those fixed costs, penetration pricing can boost sales and provide large increases in
profits—but only if the market size grows or if competitors choose not to respond. Low prices
can attract additional buyers to the market. The increased sales can justify production
expansion or the adoption of new technologies, both of which can reduce costs. And, if firms
have excess capacity, even low-priced business can provide incremental dollars toward fixed
costs.
Penetration pricing can also be effective if an experience curve will cause costs per unit
to drop significantly. The experience curve proposes that per-unit costs will go down as a
firm‘s production experience increases. Manufacturers that fail to take advantage of these
effects will find themselves at a competitive cost disadvantage relative to others that are further
along the curve.
The big advantage of penetration pricing is that it typically discourages or blocks

competition from entering a market. The disadvantage is that penetration means gearing up
for mass production to sell a large volume at a low price. If the volume fails to materialize, the
company will face huge losses from building or converting a factory to produce the failed
product.
Status Quo Pricing is the third basic price strategy a firm may choose is status quo
pricing. Recall that this pricing strategy means charging a price identical to or very close to
the competition‘s price. Although status quo pricing has the advantage of simplicity, its
disadvantage is that the strategy may ignore demand or cost or both. If the firm is
comparatively small, however, meeting the competition may be the safest route to long- term
survival.
Fine-tune the base price with pricing tactics
Tactics for Fine-Tuning the Base Price
After managers understand both the legal and the marketing consequences of price
strategies, they should set a base price—the general price level at which the company expects
to sell the good or service. The general price level is correlated with the pricing policy: above
the market (price skimming), at the market (status quo pricing), or below the market
(penetration pricing). The final step, then, is to fine-tune the base price.
Fine-tuning techniques are approaches that do not change the general price level. They
do, however, result in changes within a general price level. These pricing tactics allow the firm
to adjust for competition in certain markets, meet ever-changing government regulations, take
advantage of unique demand situations, and meet promotional and positioning goals. Fine-
tuning pricing tactics include various sorts of discounts, geographic pricing, and other pricing
strategies.
a. Discounts, Allowances, Rebates, and Value-Based Pricing
A base price can be lowered through the use of discounts and the related tactics of
allowances, rebates, low or zero percent financing, and value-based pricing. Managers use
the various forms of discounts to encourage customers to do what they would not ordinarily
do, such as paying cash rather than using credit, taking delivery out of season, or performing
certain functions within a distribution channel. The following are the most common tactics:
• Quantity discounts: When buyers get a lower price for buying in multiple units or
above a specified dollar amount, they are receiving a quantity discount.
• A cumulative quantity discount is a deduction from list price that applies to the
buyer‘s total purchases made during a specific period; it is intended to encourage
customer loyalty. In contrast, a noncumulative quantity discount is a deduction from
list price that applies to a single order rather than to the total volume of orders placed
during a certain period. It is intended to encourage orders in large quantities.
• Cash discounts: A cash discount is a price reduction offered to a consumer, an
industrial user, or a marketing intermediary in return for prompt payment of a bill.
Prompt payment saves the seller carrying charges and billing expenses and allows the
seller to avoid bad debt.
• Functional discounts: When distribution channel intermediaries, such as wholesalers
or retailers, perform a service or function for the manufacturer, they must be
compensated. This compensation, typically a percentage discount from the base price,
is called a functional discount (or trade discount). Functional discounts vary greatly
from channel to channel, depending on the tasks performed by the intermediary.
• A seasonal discount is a price reduction for buying merchandise out of season. It
shifts the storage function to the purchaser. Seasonal discounts also enable
manufacturers to maintain a steady production schedule year-round.
• Gambled price discounts: The customer receives a discount based upon the
outcome of a probabilistic gamble (and which is therefore uncertain). Discounts
involving uncertainty have been growing in popularity recently. Sears‘ Super Scratch
event involved customers receiving a scratch-and-save card that granted savings up to
$500. After paying, the cashier scratched the card to reveal the discount. This is similar
to a roll-the-dice discount, which involves paying for the item and then rolling dice to
determine the discount. Several apparel chains (such as Jack Jones and Mustang
Jeans) and restaurants (such as Hooters) have conducted roll-the-dice campaigns.
Research shows that regular price discounts can create expectations of lower prices.
This can have a negative impact on profitability. Gambled price discounts, however,
tend not to create long-run expectations of lower prices.
• A promotional allowance (also known as a trade allowance) is a payment to a dealer
for promoting the manufacturer‘s products. It is both a pricing tool and a promotional
device. As a pricing tool, a promotional allowance is like a functional discount. If, for
example, a retailer runs an ad for a manufacturer‘s product, the manufacturer may pay
half the cost.
• A rebate is a cash refund given for the purchase of a product during a specific period.
The advantage of a rebate over a simple price reduction for stimulating demand is that
a rebate is a temporary inducement that can be taken away without altering the basic
price structure. A manufacturer that uses a simple price reduction for a short time may
meet resistance when trying to restore the price to its original, higher level.
• Coupons: A coupon is a discount offered via paper, a card, a printable web page, or
an electronic code. U.S. marketers issue more than 310 billion coupons each year, 2.75
billion of which are redeemed. This redemption rate of less than 1 percent has held
steady for many years.
• Zero percent financing: To get consumers into automobile showrooms,
manufacturers sometimes offer zero percent financing, which enable purchasers to
borrow money to pay for new cars with no interest charge. This tactic creates a huge
increase in sales, but is not without its costs. A five-year interest-free car loan typically
represents a loss of more than $3,000 for the car‘s manufacturer.
• Free shipping: Free shipping is another method of lowering the price for purchasers.
However, since shipping is an expense to the seller, it must be built into the cost of the
product. Amazon spends about $6.6 billion on shipping but brings in only about $3.1
billion in payments for shipping. Amazon, Best Buy, and Gap recently raised their
minimum order requirements to receive free shipping.
• Value-based pricing, also called value pricing, is a pricing strategy that has grown out
of the quality movement. Value-based pricing starts with the customer, considers the
competition and associated costs, and then determines the appropriate price. Value-
based pricing means setting the price at a level that seems to the customer to be a
good price compared to the prices of other options. The basic assumption is that the
firm is customer driven, seeking to understand the attributes customers want in the
goods and services they buy and the value of that bundle of attributes to customers.
Because very few firms operate in a pure monopoly, however, a marketer using value-
based pricing must also determine the value of competitive offerings to customers.
Customers determine the value of a product (not just its price) relative to the value of
alternatives. In value-based pricing, therefore, the price of the product is set at a level that
seems to the customer to be a good price compared with the prices of other options. Research
has found that loyal customers become even more loyal when they receive discounts. Also,
customers who are loyal because of superior service and quality is less likely to bargain over
price.
b. Geographic Pricing
Because many sellers ship their wares to a nationwide or even a worldwide market, the
cost of freight can greatly affect the total cost of a product. Sellers may use several different
geographic pricing tactics to moderate the impact of freight costs on distant customers. The
following methods of geographic pricing are the most common:
• FOB origin pricing: FOB origin pricing, also called FOB factory or FOB shipping point,
is a price tactic that requires the buyer to absorb the freight costs from the shipping
point (free on board). The farther buyers are from sellers, the more they pay, because
transportation costs generally increase with the distance merchandise is shipped.
• Uniform delivered pricing: If the marketing manager wants total costs, including
freight, to be equal for all purchasers of identical products, the firm will adopt uniform
delivered pricing, or ―postage stamp‖ pricing. With uniform delivered pricing, the
seller pays the actual freight charges and bills every purchaser an identical, flat freight
charge. This is sometimes called postage stamp pricing because a person can send a
letter across the street or across the country for the same price.
• Zone pricing: A marketing manager who wants to equalize total costs among buyers
within large geographic areas—but not necessarily all of the seller‘s market area— may
modify the base price with a zone pricing tactic. Zone pricing is a modification of
uniform delivered pricing. Rather than using a uniform freight rate for the entire United
States (or its total market), the firm divides it into segments or zones and charges a flat
freight rate to all customers in a given zone.
• Freight absorption pricing: In freight absorption pricing, the seller pays all or part
of the actual freight charges and does not pass them on to the buyer. The manager
may use this tactic in intensely competitive areas or as a way to break into new market
areas.
• Basing-point pricing: With basing-point pricing, the seller designates a location as
a basing point and charges all buyers the freight cost from that point, regardless of the
city from which the goods are shipped. Thanks to several adverse court rulings, basing-
point pricing has waned in popularity. Freight fees charged when none were actually
incurred, called phantom freight, have been declared illegal.
c. Other Pricing Tactics
Unlike geographic pricing, other pricing tactics are unique and defy neat categorization.
Managers use these tactics for various reasons—for example, to stimulate demand for specific
products, to increase store patronage, and to offer a wider variety of merchandise at a specific
price point. Such pricing tactics include a single-price tactic, flexible pricing, professional
services pricing, price lining, leader pricing, bait pricing, odd– even pricing, price bundling, and
two-part pricing.
• Single-Price Tactic: A merchant using a single price tactic offers all goods and
services at the same price (or perhaps two or three prices).
• Flexible Pricing: Flexible pricing (or variable pricing) means that different customers
pay different prices for essentially the same merchandise bought in equal quantities.
This tactic is often found in the sale of shopping goods, specialty merchandise, and
most industrial goods except supply items. Car dealers and many appliance retailers
commonly follow the practice. It allows the seller to adjust for competition by meeting
another seller‘s price. Thus, a marketing manager with a status quo pricing objective
might readily adopt the tactic.
Flexible pricing also enables the seller to close a sale with price-conscious consumers.
The obvious disadvantages of flexible pricing are the lack of consistent profit margins, the
potential ill will of high-paying purchasers, the tendency for salespeople to automatically lower
the price to make a sale, and the possibility of a price war among sellers.
• Professional Services Pricing is used by people with lengthy experience, training,
and often certification by a licensing board—for example, lawyers, physicians, and
family counselors. Professionals sometimes charge customers at an hourly rate, but
sometimes fees are based on the solution of a problem or performance of an act (such
as an eye examination) rather than on the actual time involved. Those who use
professional pricing have an ethical responsibility not to overcharge a customer.
Because demand is sometimes highly inelastic, such as when a person requires heart
surgery to survive, there may be a temptation to charge ―all the traffic will bear.
• Price Lining: When a seller establishes a series of prices for a type of merchandise, it
creates a price line. Price lining is the practice of offering a product line with several
items at specific price points. Wireless providers use price lining for cell phones that
are purchased with a two-year contract. Price lining reduces confusion for both the
salesperson and the consumer. The buyer may be offered a wider variety of
merchandise at each established price. Price lines may also enable a seller to reach
several market segments. For buyers, the question of price may be quite simple: all
they have to do is find a suitable product at the predetermined price.
Moreover, price lining is a valuable tactic for the marketing manager, because the firm
may be able to carry a smaller total inventory than it could without price lines. The results may
include fewer markdowns, simplified purchasing, and lower inventory carrying charges. Price
lines also present drawbacks, especially if costs are continually rising. Sellers can offset rising
costs in three ways. First, they can begin stocking lower-quality merchandise at each price
point. Second, sellers can change the prices, although frequent price line changes confuse
buyers. Third, sellers can accept lower profit margins and hold quality and prices constant.
This third alternative has short-run benefits, but its long-run handicaps may drive sellers out
of business.
• Leader Pricing (or loss-leader pricing) is an attempt by the marketing manager to

attract customers by selling a product near or even below cost in the hope that
shoppers will buy other items once they are in the store. This type of pricing appears
weekly in the newspaper advertising of supermarkets. Leader pricing is normally used
on well-known items that consumers can easily recognize as bargains. Leader pricing
is not limited to products. Health clubs offer a one-month free trial as a loss leader.
• Bait Pricing: In contrast to leader pricing, which is a genuine attempt to give the
consumer a reduced price, bait pricing is deceptive. Bait pricing tries to get consumers
into a store through false or misleading price advertising and then uses high-pressure
selling to persuade them to buy more expensive merchandise. You may have seen this
ad or a similar one: This is bait. When a customer goes in to see the machine, a
salesperson says that it has just been sold or else shows the prospective buyer a piece
of junk. Then the salesperson says, ―But I‘ve got a really good deal on this fine new
model. This is the switch that may cause a susceptible consumer to walk out with a $400
machine. The Federal Trade Commission considers bait pricing a deceptive act and
has banned its use in interstate commerce. Most states also ban bait pricing, but
sometimes enforcement is lax.
• Odd–Even Pricing (or psychological pricing) means pricing at odd numbered prices
to connote a bargain and pricing at even-numbered prices to imply quality. For years,
many retailers have priced their products in odd numbers— for example, $99.95—to
make consumers feel they are paying a lower price for the product. Even-numbered
pricing is often used for prestige items, such as a fine perfume at $100 a bottle or a
good watch at $1,000. The demand curve for such items would also be saw-toothed,
except that the outside edges would represent even numbered prices and, therefore,
elastic demand.
• Price Bundling is marketing two or more products in a single package for a special
price. For example, Microsoft offers ―suites of software that bundle spreadsheets,
word processing, graphics, e-mail, Internet access, and groupware for networks of
microcomputers. Price bundling can stimulate demand for the bundled items if the
target market perceives the price as a good value. Services like hotels and airlines sell
a perishable commodity (hotel rooms and airline seats) with relatively fixed costs.
Bundling can be an important income stream for these businesses because the variable
costs tend to be low—for instance, the cost of cleaning a hotel room. To account for this
variability, hotels sometimes charge a resort fee that covers things like use of the gym, pool,
and Wi-Fi. Bundling is also widely used in the telecommunications industry. Companies offer
local service, long distance, DSL Internet service, wireless, and even cable television in various
bundled configurations. Telecom companies use bundling as a way to protect their market
share and fight off competition by locking customers into a group of services. For consumers,
comparison shopping may be difficult since they may not be able to determine how much they
are really paying for each component of the bundle.
You inevitably encounter bundling when you go to a fast food restaurant. McDonald‘s
Happy Meals and Value Meals are bundles, and customers can trade up these bundles by
super sizing them. Super sizing provides a greater value to the customer and creates more
profits for the fast food chain.
• Two-Part Pricing means establishing two separate charges to consume a single good
or service. Consumers sometimes prefer two part pricing because they are uncertain
about the number and the types of activities they might use at places like an
amusement park. Also, the people who use a service most often pay a higher total
price. Two-part pricing can increase a seller‘s revenue by attracting consumers who
would not pay a high fee even for unlimited use.
For example, a health club might be able to sell only 100 memberships at $700 annually
with unlimited use of facilities, for a total revenue of $70,000. However, it could sell 900
memberships at $200 with a guarantee of using the racquetball courts ten times a month.
Every use over ten would require the member to pay a $5 fee. Thus, membership revenue
would provide a base of $180,000, with some additional usage fees throughout the year.
• Pay What You Want: To many people, paying what you want or what you think
something is worth is a very risky tactic. Obviously, it would not work for expensive
durables like automobiles. Imagine someone paying $1 for a new BMW! Yet this model
has worked in varying degrees in digital media marketplaces, restaurants, and other
service businesses. Social pressures can come into play in a pay what you want
environment because an individual does not want to appear poor or cheap to his or her
peers.
• Package Content Reduction: Manufacturers can keep the price and package size the
same while reducing the amount of content, thereby increasing the price per ounce or
pound.
• Consumer Penalties: More and more businesses are adopting consumer
penalties—extra fees paid by consumers for violating the terms of a purchase
agreement. Airlines often charge a fee for changing a return date on a ticket.
Businesses impose consumer penalties for two reasons: they will allegedly (1) suffer
an irrevocable revenue loss and/or (2) incur significant additional transaction costs
should customers be unable or unwilling to complete their purchase obligations.
For the company, these customer payments are part of doing business in a highly
competitive marketplace. With profit margins in many companies increasingly coming under
pressure, organizations are looking to stem losses resulting from customers not meeting their
obligations. Some medical professionals charge a penalty fee if you don‘t show up for an
appointment. However, the perceived unfairness of a penalty may affect some consumers‘
willingness to patronize a business in the future.
Link to reference video lesson:

https://youtu.be/sF6AMj3H0jg?si=3jY_xrAmePgAiDCo
https://youtu.be/T2MWJK0EWqw?si=ukS9pGDXyyYOzs9s
ACTIVITIES/ ASSESSMENTS
1. What is price? Define in your own words.
2. What is the importance of pricing? Explain.
3. Identify and discuss the different categories of pricing objectives.
4. What is the four-step process of pricing? Explain each step.

TOPIC 2 – PRICING STRATEGIES
OVERVIEW
Setting the right price is one of the marketer‘s most difficult tasks. A host of factors come
into play. But finding and implementing the right price strategy is critical to success. The price
the company charges will fall somewhere between one that is too high to produce any demand
and one that is too low to produce a profit. Figure 2.1 summarizes the major considerations
in setting price. Customer perceptions of the product‘s value set the ceiling for prices. If
customers perceive that the product‘s price is greater than its value, they will not buy the
product. Product costs set the floor for prices.
If the company prices the product below its costs, the company‘s profits will suffer. In
setting its price between these two extremes, the company must consider several internal and
external factors, including competitors‘ strategies and prices, the overall marketing strategy
and mix, and the nature of the market and demand. Figure 2.1 suggests three major pricing
strategies: customer value-based pricing, cost based pricing, and competition-based pricing
Figure 2.1
Major Pricing Strategies
LEARNING OUTCOMES

• Identify and discuss the three major pricing strategies, the importance of understanding
customer-value perceptions, company costs, and competitor strategies when setting
prices.
COURSE MATERIALS
TOPIC 2 – PRICING STRATEGIES
• Customer-value based Pricing

• Cost-based Pricing
• Competition-based Pricing
CUSTOMER-VALUE BASED PRICING
In the end, the customer will decide whether a product‘s price is right. Pricing decisions,
like other marketing mix decisions, must start with customer value. When customers buy a
product, they exchange something of value (the price) to get something of value (the benefits
of having or using the product). Effective, customer-oriented pricing involves understanding
how much value consumers place on the benefits they receive from the product and setting a
price that captures this value.
Customer value-based pricing sets price by using 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 all
other marketing mix variables before the marketing program is set. The comparison between
value- based pricing with cost-based pricing is shown in Figure 2.1. Although costs are an
important consideration in setting prices, cost-based pricing is often product driven. The
company designs what it considers to be a good product, adds up 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.
Value-based pricing reverses this process. The company first assesses customer needs
and value perceptions. It then sets its target price based on customer perceptions of value.
The targeted value and price drive decisions about what costs can be incurred and the
resulting product design. As a result, pricing begins with analyzing consumer needs and value
perceptions, and the price is set to match perceived value. It‘s important to remember that
―good value is not the same as low price.
Companies often find it hard to measure the value 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 value to other satisfactions such as taste, environment, relaxation,
conversation, and status is very hard. Such value is subjective; it varies both for different
consumers and different situations.
Still, consumers will use these perceived values to evaluate a product‘s price, so the
company must work to measure them. Sometimes, companies ask consumers 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. According to an
old Russian proverb, there are two fools in every market—one who asks too much and one
who asks too little. If the seller charges more than the buyers‘ perceived value, the company‘s
sales will suffer. If the seller charges less, its products sell very well, but they produce less
revenue than they would if they were priced at the level of perceived value. We now examine
two types of value-based pricing: good-value pricing and value-added pricing
1. Good-Value Pricing
Recent economic events have caused a fundamental shift in consumer attitudes toward
price and quality. In response, many companies have changed their pricing approaches to
bring them in line with changing economic conditions and consumer price perceptions. More
and more, marketers have adopted good-value pricing strategies— offering the right
combination of quality and good service at a fair price.
In many cases, this has involved introducing less-expensive versions of established,

brand-name products. To meet tougher economic times and more frugal consumer spending
habits, fast-food restaurants such as Taco Bell and McDonald‘s offer value meals and dollar
menu items. Armani offers the less-expensive, more-casual Armani Exchange fashion line.
Alberto-Culver‘s TRESemmé hair care line promises ―A salon look and feel at a fraction of
the price.‖ And every car company now offers small, inexpensive models better suited to the
strapped consumer‘s budget.
In other cases, good-value pricing has involved redesigning existing brands to offer more
quality for a given price or the same quality for less. Some companies even succeed by offering
less value but at rock-bottom prices. For example, passengers flying the low- cost European
airline Ryanair won‘t get much in the way of free amenities, but they‘ll like the airline‘s
unbelievably low prices.
An important type of good-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. Retailers such as Costco and the furniture seller Room & Board practice EDLP.
The king of EDLP is Walmart, which practically defined the concept. Except for a few sale
items every month, Walmart promises everyday low prices on everything it sells. In contrast,
high-low pricing involves charging higher prices on an everyday basis but running frequent
promotions to lower prices temporarily on selected items. Department stores such as Kohl‘s
and Macy‘s practice high-low pricing by having frequent sales days, early-bird savings, and
bonus earnings for store credit-card holders.
2. Value-Added Pricing
Value-based pricing doesn‘t mean simply charging what customers want to pay or setting
low prices to meet competition. Instead, many companies adopt value-added pricing
strategies. Rather than cutting prices to match competitors, they attach value- added features
and services to differentiate their offers and thus support higher prices. For example, at a time
when competing restaurants lowered their prices and screamed value in a difficult economy,
fast-casual chain Panera Bread has prospered by adding value and charging accordingly.
COST-BASED PRICING
Whereas customer-value perceptions set the price ceiling, costs set the floor for the price
that the company can charge. Cost-based pricing involves setting prices based on the costs
for producing, distributing, and selling the product plus a fair rate of return for its effort and
risk. A company‘s costs may be an important element in its pricing strategy.
Some companies, such as Ryanair and Walmart, work to become the ―low-cost
producers in their industries. Companies with lower costs can set lower prices that result in
smaller margins but greater sales and profits. However, other companies—such as Apple,
BMW, and Steinway— intentionally pay higher costs so that they can claim higher prices and
margins. For example, it costs more to make a ―handcrafted Steinway piano than a Yamaha
production model. But the higher costs result in higher quality, justifying that eye-popping
$72,000 price. The key is to manage the spread between costs and prices—how much the
company makes for the customer value it delivers.
Types of Costs
A company‘s costs take two forms: fixed and variable. 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. Variable costs vary directly with the level of production. Each PC
produced by HP involves a cost of computer chips, wires, plastic, packaging, and other inputs.
Although these costs tend to be the same for each unit produced, they are called variable
costs because the total varies with the number of units produced. 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 its
competitors to produce and sell a similar product, the company will need 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) built a plant to produce 1,000
calculators per day. Figure 2.2A 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, the average cost per unit decreases. 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.
Figure 2.2
Cost per Unit at Different Levels of Production per Period
If 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 2.2B). In
fact, a 3,000- capacity plant would be even more efficient, according to Figure 2.2B.
But a 4,000-daily production plant would be less efficient because of increasing

diseconomies of scale—too many workers to manage, paperwork slowing things down, and
so on. Figure 2.2B shows that a 3,000-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 Texas Instruments (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, the average cost tends to decrease with accumulated production experience.
This is shown in Figure 2.3. 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 $8.50. 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 experience curve (or the learning curve).
Figure 2.3
Cost per Unit as a Function of Accumulated Production: The Experience
Curve
If 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. And 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.
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 those of the market leader, who still operates on the old experience
curve.
Cost-Plus Pricing
The simplest pricing method is cost-plus pricing (or markup pricing)—adding 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 often price this way to the government. To illustrate markup
pricing, suppose a toaster manufacturer had the following costs and expected sales:
Variable cost $10
Fixed costs $300,000
Expected unit sales 50,000
Then the manufacturer‘s cost per toaster is given by the following:
unit cost = variable cost + fixed costs = $10 + $300,000 = $16
unit sales 50,000
Now suppose the manufacturer wants to earn a 20 percent markup on sales.

The manufacturer‘s markup price is given by the following:
markup price unit cost = $16 = $20

=
(1 - desired return on sales) 1-2
The manufacturer would charge dealers $20 per 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 the 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. 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 pricing; they do not need to
make frequent adjustments as demand changes. Second, when all firms in the industry use
this pricing method, prices tend to be similar, so price competition is 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 break-even pricing (or a variation called

target return pricing). Break-even pricing (target return pricing) Setting price to break
even on the costs of making and marketing a product or setting price to make a target return.
The firm tries to determine the price at which it will break even or make the target return it is
seeking.
Target return pricing uses the concept of a break-even chart, which shows the total cost and total revenue
expected at different sales volume levels. Figure 2.4 shows a breakeven 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.
Figure 2.4
Break-Even Chart for Determining Target-Return Price and Break-Even 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. The 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:
break-even volume fixed cost = $300,000 =

= 30,000
price - variable cost $20 - $10
If the company wants to make a 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
a 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 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 2.1. The table shows that as
price increases, the break-even volume drops (column 2). But as price increases, the demand
for toasters also decreases (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.
Table 2.1
Break-Even Volume and Profits at Different Prices
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 return of $200,000. To achieve
this return, the manufacturer will have to search for ways to lower the fixed or variable costs,
thus lowering the break-even volume.
COMPETITION-BASED PRICING
Competition-based pricing involves setting prices based on competitors‘ strategies,

costs, prices, and market offerings. Consumers will base their judgments of a product‘s value
on the prices that competitors charge for similar products. In assessing competitors‘ pricing
strategies, the company should ask several questions.
First, how does the company‘s market offering compare with competitors‘ offerings in
terms of customer value? If consumers perceive that the company‘s product or service
provides greater value, the company can charge a higher price. If consumers perceive less
value relative to competing products, the company must either charge a lower price or change
customer perceptions to justify a higher price. Next, how strong are current competitors, and
what are their current pricing strategies? If the company faces a host of smaller competitors
charging high prices relative to the value they deliver, it might charge lower prices to drive
weaker competitors from the market. If the market is dominated by larger, low-price
competitors, the company may decide to target unserved market niches with value-added
products at higher prices.
Two Forms of Competition-Based Pricing
1. Going-rate pricing
In going-rate pricing, the 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 as, more, or less
than its chief 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 petrol retailers usually charge slightly less than the big oil
companies, without letting the difference increase or decrease.
Although it gives firms little control of their revenue, going-rate pricing can be 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.
2. Sealed-bid pricing
In sealed-bid pricing, a firm bases its price on how it thinks competitors will price rather
than on its own costs or on demand. Would-be suppliers can submit only one bid and cannot
know the other bids. Sealed-bid auctions, where buyers submit secret bids, have always been
common in business-to-business (B2B) marketing and some consumer markets. Governments
also often use this method to procure supplies.
Until the advent of the Internet, haggling (one-to-one negotiations) and a non- negotiable
price had grown to dominate pricing. Auctions existed in specialized markets, such as
commodities, some specialized financial services, fine art and antiques. Now, led by
eBay.com, online auctions for Beanie Babies and much more have become one of the most
influential Internet innovations. Whereas conventional auctions needed the market to gather
for an auction or have simultaneous telephone contact, the Internet‘s global reach and
simultaneity are putting auctions at the centre of trading. If forecasters are correct, auctions
are set to become an increasingly common part of everyone‘s life. B2B is currently the
dominant form but consumer-based auctions, both B2C and C2C, are now running at an
estimated a 20 billion a year. Because of the growth in popularity of auctions, especially with
the growth of the Internet, companies should be aware of the array of auction-type pricing
procedures. Here, we discuss sealed-bid pricing as a form of auction- type pricing as well as
address recent developments in auction-type pricing.
Economists see auctions as an efficient way of matching supply and demand but they
do introduce uncertainty into transactions. The sellers do not know the price they will receive
and buyers have no guarantee of making a purchase. One of the most common forms of
auction, sealed-bid pricing, is an example.
First-price sealed-bid pricing occurs in two ways. Potential buyers may be asked to
submit sealed bids, and the item is awarded to the buyer who offers the highest price.
Conversely, firms may have to bid for a contract to supply goods or services that is awarded
to the contender with the lowest price.
In sealed-bid pricing, a firm bases its bid price on how it thinks competitors will bid. To
win a contract, a contender has to price below 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.
The net effect of the two opposite pulls can be described in terms of the expected profit
of the particular bid as shown in Table 2.2.
Table 2.2
Effects of Different Bids on Expected Profit
Suppose a bid of €9,500 would yield a high chance (say, 0.81) of getting the contract, but
only a low profit (say, €100). The expected profit with this bid is therefore €81. If the firm bid
€11,000, its profit would be €1,600, but its chance of getting the contract might be reduced to
0.01. The expected profit would be only €16. Thus the company might bid the price that would
maximize the expected profit. According to Table 2.2, the best bid would be €10,000, for which
the expected profit €216.
Using expected profit as a basis for setting price makes sense for the large firm that
makes many bids. In playing the odds, the firm will make maximum profits in the long run. But
a firm that bids only occasionally or needs a particular contract badly will not find the expected-
profit approach useful. The approach, for example, does not distinguish between a €100,000
profit with a 0.10 probability and a €12,500 profit with a 0.80 probability. Yet the firm that wants
to keep production going would prefer the second contract to the first.
In English auctions the price is raised successively until only one bidder remains. This
is the most common auction form, familiar from scenes of rare items, be it a Van Gogh or a
pair of Madonna‘s pants, being sold by one of the great auction houses, such as Sotheby‘s or
Christie‘s. These have joined eBay as providers of online auctions aimed at its network of
regular dealers (sothebys.com) or, for smaller collectables ($100 to $100,000), at
consumers (sothebys.amazon.com). One of the largest European operators, qxl.com,
operates both B2C and C2C while on holidayauctions.net customers can bid for bargain late-
break holidays.
In Dutch auctions prices start high and are lowered successively until someone buys.
These auctions originated in the Dutch wholesale flower markets. B2B online traders, such as
Bidbusiness.co.uk and constrauction.com, use both English and Dutch auctions to sell
industrial products.
In collective buying increasing numbers of customers agree to buy as prices are

lowered to the final bargain. The more customers join in, the lower the price becomes until a
minimum demand is met. Letsbuyit.com and adabra.com offer each auction over a limited
period for each option, then move on to the next batch. These sites often offer batches of
products, say several items of kitchen equipment that are most suited to B2B markets.
In a reverse auction customers name the price that they are willing to pay for an item
and seek a company willing to sell. In pioneering their online service priceline.com takes
advantage of two major trends: first, most industries being in a continual state of excess
capacity and, second, customers being brand neutral‘ if they can get a good deal. Most of
Priceline‘s business is in travel services and mortgages but it is moving into life insurance,
groceries and second-hand goods.
Although economists see auctions as close to Adam Smith‘s invisible hand that drives
markets, there are few cool hands at auctions. Major art auctions are social, newsworthy and
exciting events. Jim Rose, of QXL, has no doubt about why online auctions are similarly
popular: They‘re fun, they‘re entertaining, and people describe it as winning something rather
than buying‖ it. The winner‘s curse is very apparent in some South-east Asian markets where
to win, contenders pay more than high street prices. And how many people can attend an
auction and not walk away with something they had no intention of buying! The second-price
sealed bid method can reduce some of the stress. In this, sealed bids are submitted but the
buyer pays a price equal to the second-best bid.
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1. What are the three major pricing strategies? Differentiate.
2. Name and describe the two types of value-based pricing methods.
3. Discuss the importance of understanding customer-value perception.
4. What are the types of cost-based pricing and the methods of implementing each? Explain.
5. Discuss the two forms of competition-based pricing.

TOPIC 3 – NEW PRODUCT PRICING STRATEGIES
OVERVIEW
The specific strategies firms use to price goods and services grow out of the marketing
strategies they formulate to accomplish overall organizational objectives. One firm‘s marketers
may price their products to attract customers across a wide range; another group of marketers
may set prices to appeal to a small segment of a larger market; still another group may simply
try to match competitors‘ price tags.
Pricing strategies usually change as the product passes through its life cycle. The
introductory stage is especially challenging. We can distinguish between pricing a product that
imitates existing products and pricing an innovative product that is patent protected. A
company that plans to develop an imitative new product faces a product-positioning problem.
It must decide where to position the product versus competing products in terms of quality and
price. Figure 3.1 shows four possible positioning strategies.
First, the company might decide to use a premium pricing strategy – producing a high-
quality product and charging the highest price. At the other extreme, it might decide on an
economy pricing strategy – producing a lower-quality product, but charging a low price.
These strategies can coexist in the same market as long as the market consists of at least two
groups of buyers, those who seek quality and those who seek price.
Price
High Low
High Premium Strategy Good-value Strategy

Quality
Overchanging Strategy Economy Strategy

Low
Figure 3.1
Effects of Different Bids on Expected Profit
The good-value strategy represents a way to attack the premium pricer. A leading
grocery chain always uses the strapline: Strapline is a slogan often used in conjunction with
a brand‘s name, advertising and other promotions. Using an overcharging strategy, the
company overprices the product in relation to its quality. In the long run, however, customers
are likely to feel ‗taken‘. They will stop buying the product and will complain to others about
it. Thus this strategy should be avoided.
Companies bringing out an innovative, patent-protected product face the challenge of

setting prices for the first time. They can choose between two strategies: market-skimming
pricing and market-penetration pricing.
LEARNING OUTCOMES

• Identify possible positioning strategies.
• Describe the major strategies for pricing new products.
• Differentiate market-skimming and market-penetration pricing strategies.
COURSE MATERIALS
TOPIC 3 – NEW PRODUCT PRICING STRATEGIES
• Marketing - Skimming Pricing

• Market - Penetration Pricing
MARKETING - SKIMMING PRICING
Derived from the expression ―skimming the cream, skimming pricing strategies are
also known as market-plus pricing. They involve intentionally setting a relatively high price
compared with the prices of competing products. Although some firms continue to use a
skimming strategy throughout most stages of the product lifecycle, it is more commonly used
as a market-entry price for distinctive goods or services with little or no initial competition.
When the supply begins to exceed demand, or when competition catches up, the initial high
price is dropped.
Such was the case with high-definition televisions (HDTVs), whose average price was
$19,000, including installation, when they were first introduced. The resulting sticker shock kept
them out of the range of most household budgets. But nearly a decade later, price cuts have
brought LCD models into the reach of mainstream consumers. At Best Buy, shoppers can pick
up a Toshiba 19-inch flat-panel LCD model for $229.99. On the higher end, they can purchase a
Sony Bravia 60-inch flat-panel LCD model for $2,699.99.
Another example, when Apple first introduced the iPhone, its initial price was as much as
$599 per phone. The phones were purchased only by customers who really wanted the sleek new
gadget and could afford to pay a high price for it. Six months later, Apple dropped the price to
$399 for an 8GB model and $499 for the 16GB model to attract new buyers. Within a year, it
dropped prices again to $199 and $299, respectively, and you can now buy an 8GB model for
$99. In this way, Apple skimmed the maximum amount of revenue from the various segments of
the market.
Consider another example – Intel. When Intel first introduces a new computer chip, it
charges the highest price it can, given the benefits of the new chip over competing chips. It
sets a price that makes it just worthwhile for some segments of the market to adopt computers
containing the chip. As initial sales slowdown and as competitors threaten to introduce similar
chips, Intel lowers the price to draw in the next price-sensitive layer of customers.
A company may practice a skimming strategy in setting a market-entry price when it

introduces a distinctive good or service with little or no competition. Or it may use this strategy
to market higher-end goods. British vacuum cleaner manufacturer Dyson has used this
practice. Offering an entirely new design and engineering, Dyson sells several of its vacuum
cleaner models for between $400 and $600, significantly more than the average vacuum.
Even the various models of iRobot‘s Roomba vacuum sell for $200 and up, and the company
claims it does all the work for you.
In some cases, a firm may maintain a skimming strategy throughout most stages of a
product‘s lifecycle. The jewelry category is a good example. Although discounters such as Costco
and Home Shopping Network (HSN) offer heavier gold pieces for a few hundred dollars, firms
such as Tiffany and Cartier command prices ten times that amount just for the brand name.
Exclusivity justifies the pricing—and the price, once set, rarely falls.
Sometimes maintaining a high price through the product‘s lifecycle works, but sometimes
it does not. High prices can drive away otherwise loyal customers. Baseball fans may shift
from attending major league games to minor league games if available because of ticket,
parking, and food prices. Amusement park visitors may shy away from high admission prices
and head to the beach instead. If an industry or firm has been known to cut prices at certain
points in the past, consumers and retailers will expect it. If the price cut doesn‘t come,
consumers must decide whether to pay the higher tab or try a competitor‘s products.
Significant price changes in the retail gasoline and airline industries occur in the form of
a step out, in which one firm raises prices and then waits to see if others follow suit. If
competitors fail to respond by increasing their prices, the company making the step out usually
reduces prices to the original level. Although airlines are prohibited by law from collectively
setting prices, they can follow each other‘s example
Despite the risk of backlash, a skimming strategy does offer benefits. It allows a
manufacturer to quickly recover its research and development (R&D) costs. Pharmaceutical
companies, fiercely protective of their patents on new drugs, justify high prices because of
astronomical R&D costs: an average of 16 cents of every sales dollar, compared with 8 cents
for computer makers and 4 cents in the aerospace industry. To protect their brand names
from competition from lower-cost generics, drug makers frequently make small changes to
their products—such as combining the original product with a complementary prescription
drug that treats different aspects of the ailment.
A skimming strategy also permits marketers to control demand in the introductory stages
of a product‘s lifecycle and then adjust productive capacity to match changing demand. A low
initial price for a new product could lead to fulfillment problems and loss of shopper goodwill if
demand outstrips the firm‘s production capacity. The result will likely be consumer and retailer
complaints and possibly permanent damage to the product‘s image. Excess demand
occasionally leads to quality issues, as the firm strives to satisfy consumer desires for the
product with inadequate production facilities.
During the late growth and early maturity stages of its lifecycle, a product‘s price typically
falls for two reasons: (1) the pressure of competition and (2) the desire to expand its
market. Figure 3.2 shows that 10 percent of the market may buy Product X at $10.00, and
another 20 percent could be added to its customer base at a price of $8.75. Successive price
declines may expand the firm‘s market size and meet challenges posed by new competitors
Figure 3.2
Price Reductions to Increase Market Share
Market skimming makes sense only under certain conditions. First, the product‘s quality
and image must support its higher price, and enough buyers must want the product at that
price. Second, the costs of producing a smaller volume cannot be so high that they cancel the
advantage of charging more. Finally, competitors should not be able to enter the market easily
and undercut the high price.
A skimming strategy has one major chief disadvantage: it attracts competition. Potential
competitors see innovative firms reaping large financial returns and may decide to enter the
market. This new supply may force the price of the original product even lower than its
eventual level under a sequential skimming procedure. However, if patent protection or some
unique proprietary ability allows a firm to exclude competitors from its market, it may extend a
skimming strategy.
MARKET - PENETRATION PRICING
A penetration pricing strategy involves the use of a relatively low price compared with
competitive offerings, based on the theory that this initial low price will help secure market
acceptance. Marketers often price products noticeably lower than competing offerings when
they enter new industries characterized by dozens of competing brands.
Once the product achieves some market recognition through consumer trial purchases
stimulated by its low price, marketers may increase the price to the level of competing
products. Marketers of consumer products such as detergents often use this strategy. A
penetration pricing strategy may also extend over several stages of the product lifecycle as the
firm seeks to maintain a reputation as a low-price competitor.
A penetration pricing strategy is sometimes called market-minus pricing when it

implements the premise that a lower-than-market price will attract buyers and move a brand
from an unknown newcomer to at least the brand-recognition stage or even to the brand
preference stage. Because many firms begin penetration pricing with the intention of
increasing prices in the future, success depends on generating many trial purchases.
Penetration pricing is common among credit card firms, which typically offer low or zero
interest rates for a specified introductory period, then raise the rates. If competitors view the
new product as a threat, marketers attempting to use a penetration strategy often discover
that rivals will simply match their prices
Retailers may use penetration pricing to lure shoppers to new stores. Strategies might
take such forms as zero interest charges for credit purchases at a new furniture store, two-
for-one offers for dinner at a new restaurant, or an extremely low price on a single product
purchase for first-time customers to get them to come in and shop
Penetration pricing works best for goods or services characterized by highly elastic
demand. Large numbers of highly price-sensitive consumers pay close attention to this type of
appeal. The strategy also suits situations in which large-scale operations and long production
runs result in low production and marketing costs. Finally, penetration pricing may be
appropriate in market situations in which introduction of a new product will likely attract strong
competitors. Such a strategy may allow a new product to reach the mass market quickly and
capture a large share prior to entry by competitors.
For example, Dell used penetration pricing to sell high-quality computer products through
lower-cost mail-order channels. Its sales soared when IBM, Compaq, Apple and other
competitors selling through retail stores could not match their prices. The Bank of Scotland
and Winterthur of Switzerland used their Direct Line, Privilege and Churchill subsidiaries to
grab profits and share in the motor insurance market by selling direct to consumers at market-
penetrating prices. The high volume results in lower costs that, in turn, allow the discounters
to keep prices low.
Several conditions favour setting a low price. First, the market must be highly price
sensitive, so that a low price produces more market growth. Second, production and
distribution costs must fall as sales volume increases. Finally, the low price must help keep
out the competition and the penetration pricer must maintain its low-price position– otherwise
the price advantage may be only temporary.
For example, Dell faced difficult times when IBM and Compaq established their own
direct distribution channels. However, competitive market-penetration pricing to gain share
can be withering. Almost all the US‘s leading Internet service providers, including Mindspring,
PSINet, Earthlink, BBN and Netcom, are losing money as they fight for market share and new
customers.
Some auto manufacturers have been using penetration pricing for some new models to
attract customers who might not otherwise consider purchasing a vehicle during a given year
or who might be looking at a more expensive competitor. India‘s Tata Motors launched the
world‘s cheapest car: the Nano, which carries a price tag of $2,500 in India. Tata has unveiled
plans to sell the Nano in Europe, too, for about $8,000, but it has yet to confirm when the Nano
will be available in the United States. Company spokespersons indicate its price tag would be
similar to that of the European model—considerably less than the Hyundai Accent which, at a
sticker price of $9,970, is the lowest-priced car in the United States.
Consider another example - the giant Swedish retailer IKEA used penetration pricing to
boost its success in the Chinese market: When IKEA first opened stores in China in 2002,
people crowded in but not to buy home furnishings. Instead, they came to take advantage of
the freebies— air conditioning, clean toilets, and even decorating ideas.
Chinese consumers are famously frugal. When it came time to actually buy, they
shopped instead at local stores just down the street that offered knockoffs of IKEA‘s designs
at a fraction of the price. So to lure the finicky Chinese customers, IKEA slashed its prices in
China to the lowest in the world, the opposite approach of many Western retailers there. By
increasingly stocking its Chinese stores with China-made products, the retailer pushed prices
on some items as low as 70 percent below prices in IKEA‘s outlets outside China.
The penetration pricing strategy worked. IKEA now captures a 43 percent market share
of China‘s fast-growing home wares market alone, and the sales of its seven mammoth
Chinese stores surged 25 percent last year. The cavernous Beijing store draws nearly six
million visitors annually. Weekend crowds are so big that employees need to use megaphones
to keep them in control.
Several conditions must be met for this low-price strategy to work. First, the market must
be highly price sensitive so that a low price produces more market growth. Second, production
and distribution costs must decrease as sales volume increases. Finally, the low price must
help keep out the competition, and the penetration pricer must maintain its low price position.
Otherwise, the price advantage may be only temporary
Everyday Low Pricing
Closely related to penetration pricing is everyday low pricing (EDLP), a strategy

devoted to continuous low prices as opposed to relying on short-term price-cutting tactics such
as cents- off coupons, rebates, and special sales. EDLP can take two forms. In the first,
retailers such as Walmart and Lowe‘s compete by consistently offering consumers low prices
on a broad range of items.
Through its EDLP policy, Lowe‘s pledges not only to match any price the consumer sees
elsewhere but also to take off an additional percentage in some cases. Walmart states that it
achieves EDLP by negotiating better prices from suppliers and by cutting its own costs. In
addition, Walmart holds suppliers to a strict four-day delivery window. Goods that arrive at the
regional distribution center before or after the window are assessed a 3 percent penalty
The second form of the EDLP pricing strategy involves its use by the manufacturer in
dealing with channel members. Manufacturers may seek to set stable wholesale prices that
undercut offers competitors make to retailers, offers that typically rise and fall with the latest
trade promotion deals. Many marketers reduce list prices on a number of products while
simultaneously reducing promotion allowances to retailers. While reductions in allowances
mean retailers may not fund such in-store promotions as shelf merchandising and end aisle
displays, the manufacturers hope stable low prices will stimulate sales instead.
Some retailers oppose EDLP strategies. Many grocery stores, for instance, operate
on high–low strategies that set profitable regular prices to offset losses of frequent specials
and promotions. Other retailers believe EDLP will ultimately benefit both sellers and buyers.
Supporters of EDLP in the grocery industry point out that it already succeeds at two of the
biggest competitors: Walmart and warehouse clubs such as Costco.
One popular pricing myth is that a low price is a sure sell. Low prices are an easy means
of distinguishing the offerings of one marketer from other sellers, but such moves are easy to
counter by competitors. Unless overall demand is price elastic, overall price cuts will mean
less revenue for all firms in the industry. In addition, low prices may generate an image of
questionable quality.
Several conditions favour setting a low price. First, the market must be highly price
sensitive, so that a low price produces more market growth. Second, production and
distribution costs must fall as sales volume increases. Finally, the low price must help keep
out the competition and the penetration pricer must maintain its low-price position– otherwise
the price advantage may be only temporary.

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1. What are the four possible positioning strategies? Discuss
2. Compare and contrast market-skimming and market - penetration pricing strategies.
3. Discuss the conditions under market-skimming and market - penetration

pricing strategies.
4. What is the relation of everyday low pricing with penetration pricing.
TOPIC 4 – PRODUCT MIX PRICING STRATEGIES
OVERVIEW
The strategy for setting a product‘s price often has to be changed when the product is
part of a product mix. In this case, the firm looks for a set of prices that maximizes its profits
on the total product mix. Pricing is difficult because the various products have related demand
and costs and face different degrees of competition. We now take a closer look at the five
product mix pricing situations summarized in Table 4.1: product line pricing, optional product
pricing, captive product pricing, by-product pricing, and product bundle pricing
Table 4.1
Product - Mix Pricing Strategies
LEARNING OUTCOMES

• Identify and discuss product mix pricing strategies.
COURSE MATERIALS
TOPIC 4 – PRODUCT MIX PRICING STRATEGIES
• Product Line Pricing
• Optional Product Pricing

• Captive Product Pricing
• Product Bundle Pricing

PRODUCT LINE PRICING
Companies usually develop product lines rather than single products. For example,
Merloni‘s sells Indesit, Ariston and Scholte appliances with price and status ascending in that
order. There are full ranges of Indesit to Ariston appliances, from washing machines to
freezers, covering the first two price bands, while Scholte sells expensive built-in kitchen
equipment. In product line pricing, management must decide on the price steps to set between
the various products in a line.
Product line pricing means setting the price steps between various products in a
product line based on cost differences between the products, customer evaluations of different
features, and competitors‘ prices.
The price steps should take into account cost differences between the products in the
line, customer evaluations of their different features, and competitors‘ prices. If the price
difference between two successive products is small, buyers will usually buy the more
advanced product. This will increase company profits if the cost difference is smaller than the
price difference. If the price difference is large, however, customers will generally buy the less
advanced products.
In many industries, sellers use well-established price points for the products in their line.
Thus record stores might carry CDs at five price levels: budget, mid-line, full-line and imports,
ascending in price and with discounted special promotions on current chart albums. The
customer will probably associate low- to high-quality recordings with the first three price points.
Even if the prices are raised a little, people will normally buy CDs at their own preferred price
points. The seller‘s task is to establish perceived quality differences that support the price
differences.
OPTIONAL PRODUCT PRICING
Many companies use optional product pricing means offering to sell optional or
accessory products along with the main product. For example, a car buyer may choose to
order a global positioning system (GPS) and Bluetooth wireless communication. Refrigerators
come with optional ice makers. And when you order a new PC, you can select from a
bewildering array of processors, hard drives, docking systems, software options, and service
plans. Pricing these options is a sticky problem. Companies must decide which items to include
in the base price and which to offer as options.
Consider another example, a Toyota Yaris customer may choose to add satellite
navigation, a CD autochanger or a roof spoiler. Pricing these options is a sticky problem. Car
companies have to decide which items to include in the base price and which to offer as
options. BMW‘s basic cars once came famously under-equipped. Typically the 318i is about
€20,000, but the customer then has to pay extra for a radio (prices vary), electric windows
(€350), sun roof (€900) and security system (€550). The basic model is stripped of so many
comforts and conveniences that most buyers reject it. They pay for extras or buy a better-
equipped version. More recently, however, American and European carmakers have been
forced to follow the example of the Japanese carmakers and include in the basic price many
useful items previously sold only as options. The advertised price now often represents a well-
equipped car.
CAPTIVE PRODUCT PRICING
Companies that make products that must be used along with a main product are using
captive product pricing. Captive product pricing means setting a price for products that must
be used along with a main product, such as blades for a razor, games for a videogame console
and film for a camera.
Examples of captive products are razor blade cartridges, videogames, and printer
cartridges. Producers of the main products (razors, videogame consoles, and printers) often
price them low and set high markups on the supplies. Thus Gillette sells low-priced razors,
but makes money on the replacement blades.
Polaroid prices its instant cameras low (€40 for a Barbie Cam) because it makes its
money on specialized films they need (€10). And Nintendo sells its game consoles at low
prices but makes money on video game titles. In fact, whereas Nintendo‘s margins on its
consoles run at a mere 1–5 per cent, margins on its game cartridges run close to 45 per cent.
Video game sales contribute more than half the company‘s profits.
Consider another example, when Sony first introduced its PS3 videogame console,
priced at $499 and $599 for the regular and premium versions, it lost as much as $306 per
unit sold. Sony hoped to recoup the losses through the sales of more lucrative PS3 games.
However, companies that use captive product pricing must be careful. Finding the right
balance between the main product and captive product prices can be tricky. For example,
despite industry-leading PS3 videogame sales, Sony has yet to earn back its losses on the
PS3 console.
Even more, consumers trapped into buying expensive captive products may come to
resent the brand that ensnared them. This happened in the inkjet printer and cartridges
industry. In the case of services, captive product pricing is called two-part pricing. The price of
the service is broken into a fixed fee plus a variable usage rate. Thus, at Six Flags and other
amusement parks, you pay a daily ticket or season pass charge plus additional fees for food
and other in-park features.
In the case of services, this strategy is called two-part pricing. The price of the service
is broken into a fixed fee plus a variable usage rate. Thus a telephone company charges a
monthly rate – the fixed fee – plus charges for calls beyond some minimum number – the
variable usage rate. Amusement parks charge admission plus fees for food and some rides.
The service firm must decide how much to charge for the basic service and how much for the
variable usage. The fixed amount should be low enough to induce usage of the service, and
profit can be made on the variable fees.
PRODUCT BUNDLE PRICING
Using product bundle pricing, sellers often combine several products and offer the
bundle at a reduced price. Thus theatres and sports teams sell season tickets at less than the
cost of single tickets; hotels sell specially priced packages that include room, meals and
entertainment; computer makers include attractive software packages with their personal
computers, and Internet service providers sell packages that include Web access, Web
hosting, email and an Internet search programme.
Price bundling can promote the sales of products that consumers might not otherwise
buy, but the combined price must be low enough to get them to buy the bundle. In other cases,
product- bundle pricing is used to sell more than the customer really wants. Obtaining a ticket
to a rock event is sometimes difficult, but tickets to international concerts bundled with
flights, accommodation, etc., are often widely available.
For example, fast-food restaurants bundle a burger, fries, and a soft drink at a ―combo‖
price. Bath & Body Works offers ―three-fer‖ deals on its soaps and lotions (such as three
antibacterial soaps for $10). And Comcast, Time Warner, Verizon, and other
telecommunications companies bundle TV service, phone service, and high-speed Internet
connections at a low combined price. Price bundling can promote the sales of products
consumers might not otherwise buy, but the combined price must be low enough to get them
to buy the bundle.
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1. Name and briefly describe the four product mix pricing decisions.
2. Explain how product line pricing differ from optional product lining.
3. Discuss how captive product pricing differ from product bundle pricing.
TOPIC 5 – PRICE ADJUSTMENT STRATEGIES
OVERVIEW
Companies usually adjust their basic prices to account for various customer differences
and changing situations. Here we examine the seven price adjustment strategies
summarized in Table 5.1 discount and allowance pricing, segmented pricing, psychological
pricing, promotional pricing, geographical pricing, dynamic pricing, and international pricing.
Table 5.1
Price Adjustments Strategies
LEARNING OUTCOMES

• Discuss and explain how companies adjust their prices to take into account different
types of customers and situations.
COURSE MATERIALS
TOPIC 5 – PRICE ADJUSTMENT STRATEGIES
• Discount and Allowance Pricing

• Segmented Pricing
• Psychological Pricing
• Promotional Pricing
• Geographical Pricing
• Dynamic Pricing
• International Pricing
DISCOUNT AND ALLOWANCE PRICING
Most companies adjust their basic price to reward customers for certain responses, such
as the early payment of bills, volume purchases, and off-season buying. These price
adjustments— called discounts and allowances—can take many forms.
Discount is a straight reduction in price on purchases during a stated period of time or

of larger quantities. A cash discount is a price reduction to buyers who pay their bills
promptly. A typical example is 2/10, net 30‘, which means that although payment is due within
30 days, the buyer can deduct 2 per cent if the bill is paid within 10 days. The discount must
be granted to all buyers meeting these terms. Such discounts are customary in many
industries and help to improve the sellers‘ cash situation and reduce bad debts and credit-
collection costs.
A quantity discount is a price reduction to buyers who buy large volumes. A typical
example is Pilot Hi-Tecpoint pens from Staples Office Supplies at a6 for a pack of three, a10
for six and a18 for 12. Wine merchants often give 12 for the price of 11‘ and Makro, the trade
warehouse, automatically gives discounts on any product bought in bulk. Discounts provide
an incentive to the customer to buy more from one given seller, rather than from many different
sources. Price does not always decrease with the quantity purchased. More often than
realized, people pay a quantity premium, a surcharge paid by buyers who purchase high
volumes of a product.
For example, in Japan it often costs more per item to buy a 12-pack of beer or sushi
than smaller quantities because the larger packs are more giftable and therefore less price
sensitive. Quantity surcharges can also occur when the product being bought is in short
supply or in sets – for example, several seats together at a sold-out‘ rock concert or sports
event – and some small restaurants charge a premium to large groups. Similarly, in buying
antiques, it costs more to buy six complete place settings of cutlery than a single item. In this
case the price will continue to increase with volume, eight place settings costing more than six,
and 12 place settings costing more than eight.
A trade discount (also called a functional discount) is offered by the seller to trade
channel members that perform certain functions, such as selling, storing and record keeping.
Manufacturers may offer different functional discounts to different trade channels because of
the varying services they perform, but manufacturers must offer the same functional discounts
within each trade channel.
A seasonal discount is a price discount to buyers who buy merchandise or services out
of season. For example, lawn and garden equipment manufacturers will offer seasonal
discounts to retailers during the autumn and winter to encourage early ordering in anticipation
of the heavy spring and summer selling seasons. Hotels, motels and airlines will offer
seasonal discounts in their slower selling periods. Seasonal discounts allow the seller to keep
production steady or stabilize capacity utilization during the entire year.
Allowances are another type of reduction from the list price. For example, trade-in
allowances are price reductions given for turning in an old item when buying a new one. Trade
- in allowances are most common in the car industry, but are also given for other durable
goods.
Promotional allowances are payments or price reductions to reward dealers for

participating in advertising and sales-support programmes. In stable markets, price
adjustments have traditionally been relatively infrequent changes made as part of a strategy
marketing or promotional programme. The Internet is changing that. In online trading, the ink
on sticker prices often has no time to dry. Prices can change from hour to hour and from
customer to customer.
SEGMENTED PRICING
Companies will often adjust their basic prices to allow for differences in customers,
products and locations. In segmented pricing, the company sells a product or service at two
or more prices, where the difference in prices is not based on differences in costs. Segmented
pricing takes several forms:
1. Customer-segment pricing: Different customers pay different prices for the same
product or service. Museums, for example, will charge a lower admission for young
people, the unwaged, students and senior citizens. In many parts of the world, tourists
pay more to see museums, shows and national monuments than do locals.
2. Product-form pricing: Different versions of the product are priced differently, but not
according to differences in their costs. For instance, a one-liter bottle (about 34 ounces)
of Evian mineral water may cost $1.59 at your local supermarket. But a five-ounce
aerosol can of Evian Brumisateur Mineral Water Spray sells for a suggested retail price
of $11.39 at beauty boutiques and spas. The water is all from the same source in the
French Alps, and the aerosol packaging costs little more than the plastic bottles. Yet you
pay about 5 cents an ounce for one form and $2.28 an ounce for the other.
3. Location pricing: Different locations are priced differently, even though the cost of
offering each location is the same. For instance, state universities charge higher tuition
for out-of-state students, and theaters vary their seat prices because of audience
preferences for certain locations. Tickets for a Saturday night performance of Green
Day‘s American Idiot on Broadway start at $32 for a seat in the rear balcony, whereas
orchestra center seats go for $252.
4. Time pricing: Prices vary by the season, the month, the day and even the hour. Public
utilities vary their prices to commercial users by time of day and weekend versus
weekday. Movie theaters charge matinee pricing during the daytime. Resorts give
weekend and seasonal discounts. Telephone companies offer lower off-peak‘ charges,
electricity costs less at night and resorts give seasonal discounts.
For segmented pricing to be an effective strategy, certain conditions must exist. The
market must be segmentable and the segments must show different degrees of demand. The
costs of segmenting and reaching the market cannot exceed the extra revenue obtained from
the price difference.
Members of the segment paying the lower price should not be able to turn round and
resell the product to the segment paying the higher price. Competitors should not be able to
undersell the firm in the segment being charged the higher price. Nor should the costs of
segmenting and watching the market exceed the extra revenue obtained from the price
difference. Of course, the segmented pricing must also be legal.
Most importantly, segmented prices should reflect real differences in customers‘

perceived value. A consumer in higher price tiers must feel that they‘re getting their extra
money‘s worth for the higher prices paid. By the same token, companies must be careful not
to treat customers in lower price tiers as second-class citizens. Otherwise, in the long run, the
practice will lead to customer resentment and ill will.
For example, in recent years, the airlines have incurred the wrath of frustrated customers
at both ends of the airplane. Passengers paying full fare for business or first class seats often
feel that they are being gouged. At the same time, passengers in lower-priced coach seats
feel that they‘re being ignored or treated poorly
PSYCHOLOGICAL PRICING
Price says something about the product. For example, many consumers use price to
judge quality. A $100 bottle of perfume may contain only $3 worth of scent, but some people
are willing to pay the $100 because this price indicates something special.
In using psychological pricing that considers the psychology of prices and not simply
the economics; the price is used to say something about the product. For example, one study
of the relationship between price and quality perception of cars found that consumers perceive
higher- priced cars as having higher quality. By the same token, higher-quality cars are
perceived as even higher priced than they actually are.
When consumers can judge the quality of a product by examining it or by calling on past
experience with it, they use price less to judge quality. When consumers cannot judge quality
because they lack the information or skill, price becomes an important quality signal.
Psychological pricing is particularly apparent in airport duty-free shops where people buy
expensive items in unfamiliar categories. In such outlets, exquisite malt whiskies are often
sold inexpensively but inexperienced buyers are attracted by grandly packaged and
overpriced blended whiskies.
Consider another example, who‘s the better lawyer, one who charges $50 per hour or
one who charges $500 per hour? You‘d have to do a lot of digging into the respective lawyers‘
credentials to answer this question objectively; even then, you might not be able to judge
accurately. Most of us would simply assume that the higher-priced lawyer is better.
Another aspect of psychological pricing is reference prices refer to prices that buyers
carry in their minds and refer to when looking at a given product. The reference price might
be formed by noting current prices, remembering past prices or assessing the buying situation.
Sellers can influence or use these consumers‘ reference prices when setting price. For
example, a company could display its product next to more expensive ones in order to imply
that it belongs in the same class. Department stores often sell women‘s clothing in separate
departments differentiated by price: clothing found in the more expensive department is
assumed to be of better quality. Companies also can influence consumers‘ reference prices
by stating high manufacturer‘s suggested prices, by indicating that the product was originally
priced much higher or by pointing to a competitor‘s higher price.
For most purchases, consumers don‘t have all the skill or information they need to figure
out whether they are paying a good price. They don‘t have the time, ability, or inclination to
research different brands or stores, compare prices, and get the best deals. Instead, they may
rely on certain cues that signal whether a price is high or low. Interestingly, such pricing cues
are often provided by sellers, in the form of sales signs, price-matching guarantees, loss-
leader pricing, and other helpful hints.
Even small differences in price can suggest product differences. Consider a stereo priced
at €400 compared to one priced at €399. The actual price difference is only €1, but the
psychological difference can be much greater. For example, some consumers will see the
€399 as a price in the €300 range rather than the €400 range. Whereas the €399 is more
likely to be seen as a bargain price, the €400 price suggests more quality. Complicated
numbers, such as €347.41, also look less appealing than rounded ones, such as €350. Some
psychologists argue that each digit has symbolic and visual qualities that should be
considered in pricing. Thus, 8 is round and even and creates a soothing effect, whereas 7 is
angular and creates a jarring effect.
PROMOTIONAL PRICING
With promotional pricing, companies will temporarily price their products below list
price and sometimes even below cost to increase short-run sales. Promotional pricing takes
several forms. Supermarkets and department stores will price a few products as loss leaders
to attract customers to the store in the hope that they will buy other items at normal mark-ups.
A seller may simply offer discounts from normal prices to increase sales and reduce
inventories. Sellers also use special-event pricing in certain seasons to draw more customers.
Thus, large-screen TVs and other consumer electronics are promotionally priced in November
and December to attract holiday shoppers into the stores.
Manufacturers sometimes offer cash rebates to consumers who buy the product from
dealers within a specified time; the manufacturer sends the rebate directly to the customer.
Rebates have been popular with automakers and producers of cell phones and small
appliances, but they are also used with consumer packaged goods. Some manufacturers offer
low interest financing, longer warranties, or free maintenance to reduce the consumer‘s
price. This practice has become another favorite of the auto industry. The seller may simply
offer discounts from normal prices to increase sales and reduce stocks. Some manufacturers
may even offer zero-financing‘ in moves to capture customers.
Promotional pricing, however, can have adverse effects. Used too frequently and copied
by competitors, price promotions can create ―deal-prone‖ customers who wait until brands
go on sale before buying them. Or, constantly reduced prices can erode a brand‘s value in the
eyes of customers. Marketers sometimes become addicted to promotional pricing, especially
in difficult economic times. They use price promotions as a quick fix instead of sweating through
the difficult process of developing effective longer-term strategies for building their brands. But
companies must be careful to balance short-term sales incentives against long-term brand
building.
One analyst advises, when times are tough, there‘s a tendency to panic. One of the first
and most prevalent tactics that many companies try is an aggressive price cut. Price trumps
all. At least, that‘s how it feels these days. 20% off. 30% off. 50% off. Buy one, get one free.
Whatever it is you‘re selling, you‘re offering it at a discount just to get customers in the door.
But aggressive pricing strategies can be risky business. Companies should be very wary of
risking their brands‘ perceived quality by resorting to deep and frequent price cuts. Some
discounting is unavoidable in a tough economy, and consumers have come to expect it. But
marketers have to find ways to shore up their brand identity and brand equity during times of
discount mayhem.
The frequent use of promotional pricing can also lead to industry price wars. Such price
wars usually play into the hands of only one or a few competitors – those with the most efficient
operations. For example, until recently, the computer industry avoided price wars. Computer
companies, including IBM, Hewlett-Packard and Compaq, showed strong profits as their new
technologies were snapped up by eager consumers. When the market cooled, however, many
competitors began to unload PCs at discounted prices. In response, Dell, the industry‘s
undisputed low-cost leader, started a price war that only it could win.
The point is that promotional pricing can be an effective means of generating sales for
some companies in certain circumstances. But it can be damaging for other companies or if
taken as a steady diet.
GEOGRAPHICAL PRICING
A company also must decide how to price its products for customers located in different
parts of the United States or the world. Should the company risk losing the business of more-
distant customers by charging them higher prices to cover the higher shipping costs? Or
should the company charge all customers the same prices regardless of location?
Geographical pricing means setting prices for customers located in different parts of the
country or world. We will look at five geographical pricing strategies for the following
hypothetical situation:
The Peerless Paper Company is located in Atlanta, Georgia, and sells paper products to
customers all over the United States. The cost of freight is high and affects the companies
from whom customers buy their paper. Peerless wants to establish a geographical pricing
policy. It is trying to determine how to price a $10,000 order to three specific customers:
Customer A (Atlanta), Customer B (Bloomington, Indiana), and Customer C (Compton,
California).
One option is for Peerless to ask each customer to pay the shipping cost from the Atlanta
factory to the customer‘s location. All three customers would pay the same factory price
of $10,000, with Customer A paying, say, $100 for shipping; Customer B, $150; and
Customer C, $250. This is called FOB-origin pricing means a geographical pricing strategy
in which goods are placed free on board a carrier; the customer pays the freight from the factory
to the destination. At that point the title and responsibility pass to the customer, who pays the
freight from the factory to the destination. Because each customer picks up its own cost,
supporters of FOB pricing feel that this is the fairest way to assess freight charges. The
disadvantage, however, is that Peerless will be a high-cost firm to distant customers.
Uniform-delivered pricing is the opposite of FOB pricing. Here, the company charges
the same price plus freight to all customers, regardless of their location. The freight charge is
set at the average freight cost. Suppose this is $150. Uniform-delivered pricing therefore
results in a higher charge to the Atlanta customer (who pays $150 freight instead of $100) and
a lower charge to the Compton customer (who pays $150 instead of $250). Although the
Atlanta customer would prefer to buy paper from another local paper company that uses FOB-
origin pricing, Peerless has a better chance of winning over the California customer
Zone pricing falls between FOB-origin pricing and uniform-delivered pricing. The
company sets up two or more zones. All customers within a given zone pay a single total
price; the more distant the zone, the higher the price. For example, Peerless might set up an
East Zone and charge $100 freight to all customers in this zone, a Midwest Zone in which it
charges $150, and a West Zone in which it charges $250. In this way, the customers within a
given price zone receive no price advantage from the company. For example, customers in
Atlanta and Boston pay the same total price to Peerless. The complaint, however, is that the
Atlanta customer is paying part of the Boston customer‘s freight cost.
Using basing-point pricing, the seller selects a given city as a ―basing point‖ and
charges all customers the freight cost from that city to the customer location, regardless of the
city from which the goods are actually shipped. For example, Peerless might set Chicago as
the basing point and charge all customers $10,000 plus the freight from Chicago to their
locations. This means that an Atlanta customer pays the freight cost from Chicago to Atlanta,
even though the goods may be shipped from Atlanta. If all sellers used the same basing-point
city, delivered prices would be the same for all customers, and price competition would be
eliminated.
Finally, the seller who is anxious to do business with a certain customer or geographical
area might use freight-absorption pricing. Using this strategy, the seller absorbs all or part
of the actual freight charges to get the desired business. The seller might reason that if it can
get more business, its average costs will decrease and more than compensate for its extra
freight cost. Freight-absorption pricing is used for market penetration and to hold on to
increasingly competitive markets.
DYNAMIC PRICING
Throughout most of history, prices were set by negotiation between buyers and sellers.
Fixed price policies—setting one price for all buyers—is a relatively modern idea that arose
with the development of large-scale retailing at the end of the nineteenth century. Today, most
prices are set this way. However, some companies are now reversing the fixed pricing trend.
They are using dynamic pricing means adjusting prices continually to meet the
characteristics and needs of individual customers and situations.
For example, think about how the Internet has affected pricing. From the mostly fixed
pricing practices of the past century, the Internet seems to be taking us back into a new age
of fluid pricing. The flexibility of the Internet allows Web sellers to instantly and constantly
adjust prices on a wide range of goods based on demand dynamics (sometimes called real-
time pricing). In other cases, customers control pricing by bidding on auction sites such as
eBay or negotiating on sites such as Priceline. Still other companies customize their offers
based on the characteristics and behaviors of specific customers.
Dynamic pricing offers many advantages for marketers. For example, Internet sellers
such as Amazon.com can mine their databases to gauge a specific shopper‘s desires,
measure his or her means, and instantaneously tailor products to fit that shopper‘s behavior,
and price products accordingly. Catalog retailers such as L.L.Bean or Spiegel can change
prices on the fly according to changes in demand or costs, changing prices for specific items
on a day-by-day or even hour- by-hour basis. And many direct marketers monitor inventories,
costs, and demand at any given moment and adjust prices instantly
Consumers also benefit from the Internet and dynamic pricing. A wealth of price comparison
sites—such as Yahoo! Shopping, Bizrate.com, NexTag.com, Epinions.com, PriceGrabber.com,
mySimon.com, and PriceScan.com—offer instant product and price comparisons from thousands
of vendors. Epinions.com, for instance, lets shoppers browse by category or search for specific
products and brands. It then searches the Web and reports back links to sellers offering the best
prices along with customer reviews. In addition to simply finding the best product and the vendor
with the best price for that product, customers armed with price information can often negotiate
lower prices.
Dynamic pricing makes sense in many contexts; it adjusts prices according to market
forces, and it often works to the benefit of the customer. But marketers need to be careful not
to use dynamic pricing to take advantage of certain customer groups, damaging important
customer relationships.
INTERNATIONAL PRICING
Companies that market their products internationally must decide what prices to charge
in the different countries in which they operate. In some cases, a company can set a uniform
worldwide price. For example, For example, Airbus sells its jetliners at about the same price
everywhere, whether in the United States, Europe or a Third World country. However, most
companies adjust their prices to reflect local market conditions and cost considerations
The price that a company should charge in a specific country depends on many factors,
including economic conditions, competitive situations, laws and regulations, and the
development of the wholesaling and retailing system. Consumer perceptions and preferences
also may vary from country to country, calling for different prices. Or the company may have
different marketing objectives in various world markets, which require changes in pricing
strategy. For example, Samsung might introduce a new product into mature markets in highly
developed countries with the goal of quickly gaining mass-market share—this would call for a
penetration-pricing strategy. In contrast, it might enter a less-developed market by targeting
smaller, less price-sensitive segments; in this case, market-skimming pricing makes sense.
Costs play an important role in setting international prices. Travelers abroad are often
surprised to find that goods that are relatively inexpensive at home may carry outrageously
higher price tags in other countries. A pair of Levi‘s selling for $30 in the United States might
go for $63 in Tokyo and $88 in Paris. A McDonald‘s Big Mac selling for a modest $3.57 in the
United States might cost $5.29 in Norway, and an Oral-B toothbrush selling for $2.49 at home
may cost $10 in China. Conversely, a Gucci handbag going for only $140 in Milan, Italy, might
fetch $240 in the United States.
In some cases, such price escalation may result from differences in selling strategies or
market conditions. In most instances, however, it is simply a result of the higher costs of selling
in foreign markets – the additional costs of modifying the product, higher shipping and
insurance costs, import tariffs and taxes, costs associated with exchange-rate fluctuations and
higher channel and physical distribution costs.
Price has become a key element in the international marketing strategies of companies
attempting to enter emerging markets, such as China, India, and Brazil. Consider Unilever‘s
pricing strategy for developing countries:
There used to be one way to sell a product in developing markets, if you bothered to sell
there at all: Slap on a local label and market at premium prices to the elite. Unilever—the
maker of such brands as Dove, Lipton, and Vaseline—changed that. Instead, it built a
following among the world‘s poorest consumers by shrinking packages to set a price even
consumers living on $2 a day could afford. The strategy was forged about 25 years ago when
Unilever‘s Indian subsidiary found its products out of reach for millions of Indians. To lower
the price while making a profit, Unilever developed single-use packets for everything from
shampoo to laundry detergent, costing just pennies a pack. The small, affordable packages
put the company‘s premier brands within reach of the world‘s poor. Today, Unilever continues
to woo cash-strapped customers with great success. For example, its approachable pricing
helps explain why Unilever now captures 70 percent of the Brazil detergent market.
Thus, international pricing presents some special problems and complexities.

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1. Identify the various price adjustment strategies.
2. Discuss how companies adjust their basic prices to account for different
customer differences and changing situations.
3. Compare and contrast the geographic pricing strategies that companies
use for customers located in different parts of the country or the world.
TOPIC 6 – PRICING UNDER VARIOUS MARKET CONDITION
OVERVIEW
A market is the area where buyers and sellers contact each other and exchange goods
and services. Market structure is said to be the characteristics of the market. Market structures
are basically the number of firms in the market that produce identical goods and services.
Market structure influences the behavior of firms to a great extent. The market structure affects
the supply of different commodities in the market.
When the competition is high there is a high supply of commodity as different companies
try to dominate the markets and it also creates barriers to entry for the companies that intend
to join that market.
Figure 6.1
Pricing, Product, and Advertising Strategies Available to Firms in Four Types of
Competitive Markets
The seller‘s pricing freedom varies with different types of markets. Economists recognize
four types of markets, each presenting a different pricing challenge. From most competitive to
least competitive, these are pure competition, monopolistic competition, oligopoly, and pure
monopoly. Figure 6.1 shows that the type of competition dramatically influences the range of
price competition and, in turn, the nature of product differentiation and the extent of
advertising.
A firm must recognize the general type of competitive market it is in to understand the
range of both its price and non-price strategies. Examples of how prices can be affected by
the four competitive situations follow:
LEARNING OUTCOMES

• Identify and discuss pricing under various market conditions.
• Understand the different competitive markets.
COURSE MATERIALS
TOPIC 6 – PRICING UNDER VARIOUS MARKET CONDITION
Pure competition
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.
Characteristics of Pure Competition
• Very large number of producers: An important feature of this type of market system
is the presence of big number of sellers that act independently and offer their products
to large national and international markets. Example: the stock market, the exchange
market.
• Standardized product: Pure competitive firms produce a standardized product. Since
price is the same demanders won‘t care which product to buy. All goods are substitutes
of each other. They make no attempt to differentiate their products and there is not any
non-price competition, because their goods are homogeneous.
• Price-Takers: In pure competitive markets firms don‘t try to control the price, because
each firm is producing only a small amount of the total product, so increasing or
decreasing their output won‘t affect the price. We may say that firms and pure-
competitive markets are price-takers: they can‘t change the market price, they only
adjust to it. Selling their goods on a higher price will results in loss of revenue, because
1000 sellers will offer their goods for a smaller price so the consumers, since the goods
are identical, will buy less costly one, because in this way they get more marginal benefit.
There isn‘t any reason to decrease the price, because sellers want to get higher
revenues if it is possible. By decreasing price they may lose higher profits. So the price
of the sellers will be the same, since their goods are identical.
• Free entry and free exit: New firms can freely enter and the existing ones may exit the
pure competitive industry. No legal, financial, technological or other obstacles prohibit
suppliers to sell their goods in any pure-competitive market.
Even if pure competition is relatively rare in our real world, it is meaningful starting point
for any discussion about price and output determination. It provides a standard for evaluating
the efficiency of real world economy. Even if this kind of market system is extremely rare some
industry may be a close approximation of it: market for agricultural goods, foreign exchange,
and stock share market. So by means of them we can learn more about this model of market
system.
Monopolistic competition
Under monopolistic competition, the market consists of many buyers and sellers that
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.
Each company can create a quasi-monopoly for its products because 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, availability, advertising and personal selling to set their offers apart. For example,
Ty‘s Beanie Babies have cultivated a distinctive appeal that has both stimulated demand and
seen the price of some Beanies rocket.
Characteristics of Monopolistic Competition

• There are many producers and consumers in the market.
• There is not one firm that has total control over the price of the market.
• Consumers assume that there are non-price differences among the products
of competitors.
• Barriers to entry and exit exist but are few.
• Producers have some control over the prices.
• Producers and consumers have no perfect information.
Oligopoly
Under oligopolistic competition, the market consists of a few sellers that are highly
sensitive to each other‘s pricing and marketing strategies. The product can be uniform (steel,
aluminum) or non-uniform (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 per cent, buyers will quickly switch to this supplier. The
other steel makers must respond by lowering their prices or increasing their services. Good
examples include industries like oil & gas, airline, and automakers.
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 would then have to retract its price increase or risk losing customers to competitors.
Characteristics of an Oligopoly
• Only a few numbers of firms operate in the market.
• Profit maximization is a condition in this market.
• Monopolies set their own prices.
• Barriers to entry are high.
• Firms make abnormal profits in the long-run.
• Products may be homogeneous.
• There is a relatively small number of firms supplying the market.
Pure monopoly
A pure monopoly is a market structure where one company is the single source for a
product and there are no close substitutes for the product available. Pure monopolies are
relatively rare. In order for a provider to maintain a pure monopoly, there must be barriers
preventing competitors from entering the market. Let's look briefly at some possible barriers:
1. Legal barriers: While there are laws in the United States that prohibit monopolies, there
are several situations where the U.S. government allows them. In some cases, the
monopoly may exist indefinitely with the government's permission and in other cases,
a monopoly is granted for a specific period of time. Some examples of legal barriers
are government-issued licenses, copyrights, and patents.
2. Control of resources: This barrier exists when a sole provider owns or controls an
essential resource necessary to production. An example of this is Alcoa. For many years,
Alcoa was the only producer of aluminum in the United States. Alcoa obtained exclusive
mining rights to all of the bauxite aluminum ore mines in the country, and bauxite is
necessary to the production of aluminum. This prevented competitors from entering the
market.
3. Economies of scale: The economies of scale barrier occur when the average total cost
of a product goes down when production increases. Some businesses invest large
amounts of money building the infrastructure to create their product. This is a fixed cost.
Once the infrastructure is in place, the cost of producing a single unit becomes lower
for each unit added because the fixed costs are spread out over a larger number of units.
In terms of monopolies, an existing business with an established infrastructure has a
cost advantage when producing large quantities of a given product, enabling it to
undercut the competition on price. This is known as a natural monopoly and most
typically refers to public utilities such as water services, natural gas, and electricity.
Characteristics of an Oligopoly
• Significant internal economies of scale – the minimum efficient scale may be so high
that only one supplier can fully exploit available economies of scale (i.e. a natural
monopoly)
• High regulatory barriers to entry e.g. licenses required to operate, awarded
franchises can give local/regional market power. Some state-owned firms have
monopoly status.
• High trade barriers which give increased monopoly power to a domestic firm
protected by import tariffs
• A firm might have localized monopoly power with no close substitute available

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1. Explain how pure competition differs from monopolistic competition.
2. Discuss how oligopoly differs from pure monopoly.
3. Explain pricing under various market conditions.

TOPIC 7 – PUBLIC POLICY AND MARKETING
OVERVIEW
Pricing decisions are often constrained by social and legal issues. For example, think
about the pharmaceuticals industry. Are rapidly rising prescription prices justified? Or are the
drug companies unfairly lining their pockets by gouging consumers who have few alternatives?
Should the government step in?
Price competition is a core element of our free-market economy. In setting prices,

companies usually are not free to charge whatever prices they wish. Many federal, state, and
even local laws govern the rules of fair play in pricing. In addition, companies must consider
broader societal pricing concerns. In setting their prices, for example, pharmaceutical firms
must balance their development costs and profit objectives against the sometimes life-and
death needs of drug consumers
Figure 7.1 shows the major public policy issues in pricing. These include potentially
damaging pricing practices within a given level of the channel (price-fixing and predatory
pricing) and across levels of the channel (retail price maintenance, discriminatory pricing,
and deceptive pricing).
Figure 7.1
Public Policy Issues in Pricing
LEARNING OUTCOMES

• Identify and discuss the social and legal issues that affect pricing decisions.
COURSE MATERIALS
TOPIC 7 – PUBLIC POLICY AND MARKETING

• Pricing within Channel Levels
• Pricing Across Channel Levels
PRICING WITHIN CHANNEL LEVELS
Price Fixing
A conspiracy among firms to set prices for a product is termed price fixing. Price fixing
is illegal per se under the Sherman Act (per se means in and of itself). When two or more
competitors explicitly or implicitly set prices, this practice is called horizontal price fixing. For
example, in 2000, six foreign vitamin companies pled guilty to price fixing in the human and
animal vitamin industry and paid the largest fine in U.S. history, a hefty $335 million.
Vertical price fixing involves controlling agreements between independent buyers and
sellers (a manufacturer and a retailer) whereby sellers are required to not sell products below
a minimum retail price. This practice, called resale price maintenance, was declared illegal
per se in 1975 under provisions of the Consumer Goods Pricing Act. Nevertheless, this
practice is not uncommon. For example, shoe supplier Nine West was charged with restricting
competition by coercing retailers to adhere to its resale prices. As part of its settlement, Nine
West agreed to pay $34 million. Although this type of coercive price fixing is illegal per se,
manufacturers and wholesalers can fix the maximum retail price for their products provided the
price agreement does not create an unreasonable restraint of trade‖ or is anticompetitive.
It is important to recognize that a ―manufacturer‘s suggested retail price, or MSRP, is

not illegal per se. The issue of legality only arises when manufacturers enforce such a practice
by coercion. Furthermore, there appears to be a movement toward a ―rule of reason in
horizontal and vertical price fixing cases. This rule holds that circumstances surrounding a
practice must be considered before making a judgment about its legality. The rule of reason
perspective is the direct opposite of the per se rule.
Federal legislation on price-fixing states that sellers must set prices without talking to
competitors. Otherwise, price collusion is suspected. Price-fixing is illegal per se—that is, the
government does not accept any excuses for price-fixing. Companies found guilty of such
practices can receive heavy fines. Recently, governments at the state and national levels have
been aggressively enforcing price-fixing regulations in industries ranging from gasoline,
insurance, and concrete to credit cards, CDs, and computer chips.
Predatory Pricing
Predatory pricing is the practice of charging a very low price for a product with the intent
of driving competitors out of business. Once competitors have been driven out, the firm raises
its prices. This practice is illegal under the Sherman Act and the Federal Trade Commission
Act. Proving the practice of predatory pricing is difficult and expensive, because it must be
shown that the predator explicitly attempted to destroy a competitor and the predatory price
was below the defendant‘s average cost.
This protects small sellers from larger ones who might sell items below cost temporarily
or in a specific locale to drive them out of business. The biggest problem is determining just
what constitutes predatory pricing behavior. Selling below cost to unload excess inventory is
not considered predatory; selling below cost to drive out competitors is. Thus, the same action
may or may not be predatory depending on intent, and intent can be very difficult to determine
or prove.
In recent years, several large and powerful companies have been accused of predatory
pricing. However, turning an accusation into a lawsuit can be difficult. For example, many
music retailers have accused Walmart and Best Buy of predatory CD pricing. Since 2007
alone, CD sales have plummeted almost 20 percent each year, putting music-only retailers
such as Tower Records, Musicland, and a megamall full of small mom-and-pop music shops
out of business.
Many industry experts attribute slumping CD sales to new music distribution strategies—
mainly digital downloads. Others, however, blame the big-box stores for pricing CDs as loss
leaders to drive competitors out of business. Low CD prices don‘t hurt Walmart; it derives less
than 2 percent of its sales from CDs, and low-priced CDs pull customers into stores, where
they buy other products. Such pricing tactics, however, cut deeply into the profits of music
retailers. Still, no predatory pricing charges have ever been filed against Walmart or Best Buy.
It would be extremely difficult to prove that such loss-leader CD pricing is purposefully
predatory as opposed to just plain good marketing.
PRICING ACROSS CHANNEL LEVELS
The Robinson-Patman Act seeks to prevent unfair price discrimination by ensuring that
sellers offer the same price terms to customers at a given level of trade. The Clayton Act as
amended by the Robinson-Patman Act prohibits price discrimination—the practice of charging
different prices to different buyers for goods of like grade and quality. However, not all price
differences are illegal; only those that substantially lessen competition or create a monopoly
are deemed unlawful. Moreover, ―goods‖ is narrowly defined and does not include
discrimination in services.
A unique feature of the Robinson-Patman Act is that it allows for price differentials to
different customers under the following conditions:
1. When price differences charged to different customers do not exceed the differences in
the cost of manufacture, sale, or delivery resulting from differing methods or quantities
in which such goods are sold or delivered to buyers. This condition is called the cost
justification defense.
2. When price differences result from changing market conditions, avoiding obsolescence
of seasonal merchandise, including perishables, or closing out sales.
3. When price differences are quoted to selected buyers in good faith to meet competitors‘
prices and are not intended to injure competition. This condition is called the meet-the-
competition defense.
For example, every retailer is entitled to the same price terms from a given manufacturer,
whether the retailer is Sears or your local bicycle shop. However, price discrimination is
allowed if the seller can prove that its costs are different when selling to different retailers—
for example, that it costs less per unit to sell a large volume of bicycles to Sears than to sell a
few bicycles to the local dealer.
The seller can also discriminate in its pricing if the seller manufactures different qualities
of the same product for different retailers. The seller has to prove that these differences are
proportional. Price differentials may also be used to ―match competition in good faith,
provided the price discrimination is temporary, localized, and defensive rather than offensive.
The Robinson-Patman Act also covers promotional allowances. To legally offer

promotional allowances to buyers, the seller must do so on a proportionally equal basis to all
buyers distributing the seller‘s products. In general, the rule of reason applies frequently in
price discrimination disputes and is often applied to cases involving firms that use dynamic
pricing policies.
Laws also prohibit retail (or resale) price maintenance; a manufacturer cannot require
dealers to charge a specified retail price for its product. Although the seller can propose a
manufacturer‘s suggested retail price to dealers, it cannot refuse to sell to a dealer that takes
independent pricing action nor can it punish the dealer by shipping late or denying advertising
allowances. For example, the Florida attorney general‘s office investigated Nike for allegedly
fixing the retail price of its shoes and clothing. It was concerned that Nike might be withholding
items from retailers who were not selling its most expensive shoes at prices the company
considered suitable
Deceptive pricing occurs when a seller states prices or price savings that mislead
consumers or are not actually available to consumers. This might involve bogus reference or
comparison prices, as when a retailer sets artificially high regular prices and then announces
sale prices close to its previous everyday prices. For example, Overstock.com recently came
under scrutiny for inaccurately listing manufacturer‘s suggested retail prices, often quoting
them higher than the actual price. Such comparison pricing is widespread.
Figure 7.2 Deceptive Pricing Practices

Comparison pricing claims are legal if they are truthful. Deceptive pricing is outlawed by
the Federal Trade Commission Act. The FTC monitors such practices and has published a
regulation titled ―Guides against Deceptive Pricing‖ to help businesspeople avoid a charge
of deception. The five most common deceptive pricing practices are described in Figure
7.2.
As you read about these practices it should be clear that laws cannot be passed and
enforced to protect consumers and competitors against all of these practices. So it is essential
to rely on the ethical standards of those making and publicizing pricing decisions. An often
used pricing practice is to promote products and services for free—a great price! It would
seem that the meaning of free is obvious.
Other deceptive pricing issues include scanner fraud and price confusion. The
widespread use of scanner-based computer checkouts has led to increasing complaints of
retailers overcharging their customers. Most of these overcharges result from poor
management—from a failure to enter current or sale prices into the system. Other cases,
however, involve intentional overcharges.
Many federal and state statutes regulate against deceptive pricing practices. For
example, the Automobile Information Disclosure Act requires automakers to attach a
statement on new vehicle windows stating the manufacturer‘s suggested retail price, the
prices of optional equipment, and the dealer‘s transportation charges. However, reputable
sellers go beyond what is required by law. Treating customers fairly and making certain that
they fully understand prices and pricing terms is an important part of building strong and lasting
customer relationships.

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1. Name and describe the major public policy issues in pricing within a given level
of the channel.
2. Identify and discuss the public policy issues in pricing across channel levels.
3. Discuss the different deceptive pricing practices.

TOPIC 8 - DETERMINING DEMAND - CUSTOMER PERCEPTION OF PRICE
OVERVIEW
Customers perceive a total product including core benefits, product attributes, and
support services yielding a package of benefits they need. These benefits must be balanced
against the costs customers will experience to gain them.
Of course, the most important cost is the net outlay of funds required from the customer
firm to gain these benefits. This outlay is perceived by the customer not simply in terms of the
initial price, but in terms of the value received for the expenditures over the useful life of the
product.
Customer firms are rather sophisticated in their application of discounted cash flow to
pricing offered by vendors and they understand the net difference between one offer and
another. Here also, customers may choose to lease rather than own products, thereby
increasing the value of the offering to them. Customer perceptions of costs and benefits are
shown graphically in Table 8.1.
Figure 8.1
Customer Perceptions of Cost and Benefits
LEARNING OUTCOMES

• Describe key factors affecting customer price sensitivity.
• Understand the significance of Activity based costing (ABC).
• Explain the concept of Learning Curve Theory.
• Describe how understanding competitors' current position affects pricing.
COURSE MATERIALS
TOPIC 8 – DETERMINING DEMAND – CUSTOMER PERCEPTION OF PRICE
• Price Sensitivity
• Cost
• Competition
Customer Perception of Costs and Benefits
As can be seen in Table 8.1, customer benefits fall into functional, operational,
financial, personal, and relational categories. The functional are those that come to mind
most readily, related to the physical aspects of the product, specific benefits of the service or
the total benefits derived from the package of products and services.
But also important are operational benefits such as reliability and durability, financial
aspects such as the payback period, and personal benefits which some member of the buying
center may realize because of his or her choice of a particular product. Newer research
(Menon et al., 2005) adds relational benefits. Strong business relationships and joint working
arrangements increase the customer‘s perception of value. These in turn are derived from
customers‘ trust in the supplier and their perception of the supplier‘s commitment to them.
Customer costs include acquisition costs, which include the initial price less discounts
plus freight, installation and taxes, operational costs, including internal coordination, training,
possible downtime, switching costs (discussed below), and eventual disposal of the products
purchased, and finally, costs related to risk. These include both the risk to the firm which might
be caused by a product which did not function correctly and personal career-related risks.
79
Menon et al. believe that supplier trust reduces acquisition costs. In order to price a
product correctly, a manager must understand exactly how the customer perceives all these
costs and benefits. Menon et al. find that customers focus more on overall benefits in this
calculation than they do on the costs
It is critical for the marketer to fully understand the customer‘s business, to be aware of
the risks the customer faces and the ways in which the customer realizes success. Pricing in
this way means setting price based on value-in-use. Shapiro and Jackson (1978) give an
example of a DuPont pipe made of a particular resin. The pipe was introduced at a far greater
price than its competition based on the fact that its life expectancy was much higher than the
competitor‘s pipe.
Since this product is buried below ground in many applications the cost to the customer
of failure is significantly higher than the difference between DuPont‘s and the competitor‘s
offerings. The company could then price the product based on its value to the customer or its
value-in-use.
Value-in-use pricing means the vendor captures some of the benefits realized by the
customer. Macdonald et al. (2011) emphasize that value-in-use is a complex proposition and
depends very much on the context. They question whether value is delivered solely by a single
provider. In their conception, the customer is a co-creator of value and can define value-in-use
in terms of their goals or objectives.
Achieving these objectives requires employing internal as well as external assets

throughout the customer‘s network. In addition the definition of value-in-use by the customer
changes as the customer‘s goals change. They find two types of goals – preventative and
promotional. The former focuses on solving problems and the latter on increasing
organizational productivity or effectiveness.
Sharma and Iyer (2011) show that traditional pricing strategies may not be useful in
solution marketing since solutions often require special capabilities and knowledge for which
costs are not easily determined for each transaction, economies of scale may not be realized,
and customized solutions are unique and difficult to compare to competition. It is difficult for
the solution provider to know what value the customer places on the solution.
Supplier firms often believe they are selling solutions when in fact they are only selling
bundled products and services which the customer can easily de-bundle. They conclude that
most firms are using traditional pricing approaches and that value pricing models are being
very infrequently used.
81
PRICE SENSITIVITY
Dolan (1995) listed factors that affect customer price sensitivity as shown in Table 8.2
Figure 8.2
Factors affecting Customer Price Sensitivity
The major categories are customer economics, search, usage, and competition.
Customers will be more sensitive, therefore decreasing the ability of the marketing manager
to change his price, if the percentage expenditure for the particular item is large in comparison
to the total expense that the customer is making to achieve a particular end.
Pricing flexibility will also be reduced if the customer has to resell the product into a very
competitive market. Should the item be of extreme importance to the successful operations of
the customer‘s firm, price sensitivity will tend to decline because reliability becomes
paramount.
Reviewing the search and usage category, customers will be more price sensitive if
information search is easy and inexpensive and competitive offerings are easily compared. In
addition, the customer‘s price sensitivity is increased substantially where switching costs are
low. Switching costs are all the costs associated with changing from one particular product or
service to another.
82
For example, a firm might be standardized on a particular IBM computer system. A
competing manufacturer let us say Fujitsu, offers the customer a new computer system with
demonstrably better features. However, the customer would hesitate to change knowing that
the switching costs, including down-time, training, and the inevitable problems caused by such
a major change would be substantial. These costs may, indeed, outweigh the benefits seen
from a potential new system. Finally, price sensitivity is decreased where the manufacturer‘s
offering is clearly differentiated from its competition and where price perception gives an aura
of quality to a particular product.
COST
For marketing managers, developing reliable costs to use in pricing decisions is often a
frustrating process. Often, many products are made in the same factory and the allocation of
costs by the finance department is often arbitrary. Products which are easy to manufacture
and have low material costs often assume too much of the overhead of a facility, making the
marketing manager‘s task in pricing to meet market conditions quite difficult. In this regard,
marketing people are advised to study the costing process used at a particular facility in-
depth so that they can convincingly present their case for proper costing of particular product
lines.
Activity based costing (ABC) allows a firm to more accurately determine what costs
should be assigned to particular product lines and customers. According to Narayanan and
Sarkar (2002), under ABC managers separately keep an account of expenses required to
produce individual units and batches, to design and maintain and produce, and to keep the
manufacturing facility running. ABC requires that costs be allocated not only to products but
also to customers so that a manager can determine the cost to serve a particular customer.
In Narayanan and Sarkar‘s study, Insteel Corporation tracked overhead needed to serve
special customer needs including packing and loading, order processing and invoicing, post-
sales service, and the cost of carrying receivables. These costs were attributed to each
customer and allocated to product based on the volume of each product purchased by a
particular customer.
Through the ABC approach, Insteel discovered that at a particular plant studied, freight
represented 16 percent of the total people and physical resources cost. After the detailed
analysis, management decided to increase the weight shipped per truck load, resulting in a
20 percent reduction in freight expense. The visibility of the ABC system also allowed Insteel
to change the product line and increase prices for less profitable products. As described
above, developing costs for integrated solutions is much more difficult.
Although the high risks associated with it have been well-established, the idea of pricing
down the learning curve is one which has persisted for at least two decades. Learning curve
(or experience curve) theory simply states that costs decline rapidly with each doubling of
output of a particular product. Experience curve effects come from three major sources (Day
and Montgomery, 1983):
a. Learning: increased efficiency because of practice and skill or finding new and
better ways to do things.
b. Technological improvements: new production processes and product
changes which improve yield.
c. Economies of scale: increased efficiency resulting from larger operations.
These improvements are especially relevant to investment and operating costs. Day and
Montgomery found significant limitations of the strategic relevance for experience curve
approaches and they warn against an all-out dedication to this approach. While it may give
some advantages in some markets, it also introduces rigidity that may make the firm slower
and less flexible in its ability to respond to customer or competitive changes. The experience
curve will only be strategically relevant when the three major effects identified above are
important in the strategic environment of a particular firm.
Ames and Hlavacek (1984) point out that slavishly following the experience curve
approach has yielded disastrous results, especially for established or mature products where
gains through experience diminish rapidly.
Generally the aggressive (penetration) pricing approach to gain market share is justified
in three circumstances. First, in new or underdeveloped markets where customers are very
price sensitive, price may be the weapon of choice to establish a secure market presence
before competitors can move. Second, where fixed and variable costs will assuredly drop with
a rapid increase in volume. And finally where competitors are weak or have rigid high costs a
firm may use pricing to place a severe strain on its competitors who will probably not be able
to match the firm‘s lower prices (McKinsey Quarterly, 2003).
COMPETITION
Needless to say, understanding competitive offerings, including their prices, is critical.

To begin with, a firm must be careful about setting its prices higher than the competition. This
obviously depends upon the strategic position the firm finds itself in. Should the company be
a leader in its market, it probably will price higher than its competitors. In monopolistic
competition situations, smaller firms would realize no benefit by attempting to price lower than
the dominant competitor since the large firm could easily match the smaller firm‘s prices or
even retaliate by lowering prices further, putting a much larger financial strain on the smaller
firm than it would realize itself.
In high growth or hyper-competitive markets, some firms may attempt simply to disturb
the status quo. An important tool in these markets is the race to the next price point. While
this is more common in consumer markets, there is a strong effect in B2B markets as well.
Moore (1995) points out that when workstation prices were lowered to under $50,000 and then
under $10,000 the result was ―huge boosts in sales volumes.‖
He continues, the vendor who hits the next lowest price point engages a large new market
segment who previously could not afford to take advantage of a particular product or
technology. When a market leader does not move toward that price point rapidly, new
aggressive competitors will do so. This is true even in the case where these smaller
competitors have to sell below their costs. In the hyper-competitive situation, the learning curve
has its most telling effect.
Countering direct competitive efforts requires creativity to differentiate the firm‘s offering
from its competitors‘. One commodity chemical firm set up a new business unit to provide
solutions selling to its customers. While expenses increased (selling, general, and
administrative costs rose 5 percent), gross margins rose to 20 percent from 9 percent
(Johanssen et al., 2003).
Understanding your competitors‘ current position is an important factor affecting the price
but an equally important aspect of this decision is competitor reaction. Certainly, this aspect
of pricing requires experience and knowledge. A correct assessment of competitors‘ reaction
to increasing or decreasing price may determine whether the strategy chosen by the company
is the correct one. Sophisticated companies are able to include in their data warehouse
information about past competitive reactions to pricing moves. This knowledge can help the
manager make more informed decisions about potential competitive actions.

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1. What affects a customer‘s price sensitivity? Discuss
2. Explain the usage of Activity based costing (ABC)
3. Discuss the theory of learning curve and its three major sources. How understanding
competitors' current position affects pricing? Explain
TOPIC 9 – PRICE CHANGES
OVERVIEW
After developing their pricing strategies, companies often face situations in which they
must initiate price changes or respond to price changes by competitors. When and how should
a company change its price? What if costs rise, putting the squeeze on profits? What if the
economy sags and customers become more price-sensitive? Or what if a major competitor
raises or drops its prices? As Figure 9.1 suggests, companies face many price-changing
options.
Figure 9.1
Assessing and Responding to
Competitor Price Changes
When a competitor cuts prices, a company‘s first reaction may be to drop its prices as
well. But that is often the wrong response. Instead, the firm may want to emphasize the value
side of the price-value equation.
LEARNING OUTCOMES

• Discuss and explain the key issues related to initiating and responding to price
changes.
COURSE MATERIALS
TOPIC 9 – PRICE CHANGES

• Initiating Price Changes
• Responding to Price Changes
INITIATING PRICE CHANGES
In some cases, the company may find it desirable to initiate either 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, fast-food, automobile, 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 onto market share.
Another situation leading to price changes is falling market share in the face of strong
price competition. Several industries – cars, consumer electronics, cameras, watches and
steel, for example – lost market share to Japanese competitors who offered high-quality
products at lower prices than Western competitors. In response, defending companies
resorted to more aggressive pricing to hold on to their markets.
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. Lenovo uses an
aggressive low- cost, low-price strategy to increase its share of the PC market in developing
countries.
Initiating Price Increases
In contrast, many companies have had to raise prices in recent years. They do this
knowing that customers, dealers and even their own sales force may resent the price
increases. Yet a successful price increase can greatly increase profits. For example, if the
company‘s profit margin is 3 percent of sales, a 1 percent price increase will boost profits by 33
percent if the sales volume is unaffected.
A major factor in price increases is cost inflation. Rising costs squeeze profit margins
and lead companies to make 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 over-demand: When a company cannot supply all that its customers
need, it may raise its prices, ration products to customers, or both. Consider today‘s worldwide
oil and gas industry.
When raising prices, the company must avoid being perceived as a price gouger. For
example, when gasoline prices raise rapidly, angry customers often accuse the major oil
companies of enriching themselves at the expense of consumers. Customers have long
memories, and they will eventually turn away from companies or even whole industries that
they perceive as charging excessive prices. In the extreme, claims of price gouging may even
bring about increased government regulation.
There are some techniques for avoiding these problems. One is to maintain a sense of
fairness surrounding any price increase. Companies can increase their prices in a number of
ways to keep up with rising costs. Dropping discounts and adding higher-priced units to the
line can raise prices almost invisibly. Or prices can be pushed up openly. Companies have
learned to take care when passing price increases on to customers. 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.
Wherever 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. 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 price changes in a straightforward way. A price increase, which would normally lower
sales, may have some positive meanings for buyers. They may view a price cut in several
ways.
For example, what would you think if Sony were suddenly to cut its DVD prices in half?
You might think that these DVDs 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 DVD 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 the recorder is unusually good value.
A brand‘s price and image are often closely linked. A price change, especially a drop in
price, can adversely affect how consumers view the brand.
Competitor Reactions to Price Changes
A firm considering a price change must worry about the reactions of its competitors as
well as those of its customers. Competitors are most likely to react when the number of firms
involved is small, when the product is uniform, and when the buyers are well informed about
products and prices.
How can the firm anticipate the likely reactions of its competitors? If the firm faces one
large competitor and if the competitor tends to react in a set way to price changes that reaction
can be easily anticipated. But if the competitor treats each price change as a fresh challenge
and reacts according to its self-interest, the company will have to figure out just what makes
up the competitor‘s 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 or that it‘s doing poorly and trying to boost its sales. Or it might think that the company
wants the whole industry to cut prices to increase total demand.
When there are several competitors, the company must guess each competitor‘s 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 size,
market shares, or policies—then separate analyses are necessary. However, if some
competitors will match the price change, there is good reason to expect that the rest will also
match it.
RESPONDING TO PRICE CHANGES
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 issues: 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 competitors going to respond?
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
from the competitor.
Figure 6.1 shows the ways a company might assess and respond to a competitor‘s price
cut. Suppose the company learns that a competitor has cut its price and decides that this price
cut is likely to harm its 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. Or it might decide that it should wait
and respond when it has more information on the effects of the competitor‘s price change.
However, waiting too long to act might let the competitor get stronger and more confident as
its sales increase.
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.

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1. What must be considered when a firm initiates price cut or a price increase? Explain.
2. Identify and discuss the key issues related to initiating to price cuts and
initiating price increases.
3. Discuss the key issues related to responding to a competitor’s price changes.
TOPIC 10 – IDENTIFYING PRICING CONSTRAINTS
OVERVIEW
Factors that limit the range of prices a firm may set are referred to as pricing constraints.
Consumer demand for the product clearly affects the price that can be charged. Other
constraints on price vary from factors within the organization to competitive factors outside the
organization.
LEARNING OUTCOMES

• Recognize the constraints that restrict the range of prices a firm can charge.
• Understand ethical constraints on pricing.
COURSE MATERIALS
TOPIC 10 – IDENTIFYING PRICING CONSTRAINTS
IDENTIFYING PRICING CONSTRAINTS
Demand for the Product Class, Product, and Brand
The number of potential buyers for the product class (cars), product group (family
sedans) and specific brand (Toyota Camry V6) clearly affects the price a seller can charge.
Likewise, whether the item is a luxury—like the Bugatti Veyron—or a necessity—like bread
and a roof over your head—also affects the price that can be charged. Generally, the greater
the demand for a product, the higher the price that can be set. For example, the New York
Mets set different ticket prices for their games based on the appeal of their opponent—prices
are higher when they play the New York Yankees and lower when they play the Pittsburgh
Pirates.
Newness of the Product: Stage in the Product Life Cycle
The newer a product and the earlier it is in its life cycle, the higher is the price that can
usually be charged. Willing to spend $9,999 for an LG 55-inch 3D OLED HD Smart TV? The
high initial price is possible because of patents and limited competition early in its product life
cycle. By the time you read this, the price probably will be much lower.
Sometimes—when nostalgia or fad factors come into play— prices may rise later in the
product‘s life cycle. For example, collectibles can experience skyrocketing prices. Recently,
consumers on eBay paid $250 for a Zip the Cat Beanie Baby (with black paws), $200 for a
2001 Ichiro Suzuki rookie bobble-head doll, and $29,500 for a 1963 copy of the first ―Amazing
Spiderman‖ issue. But these prices can nosedive, too, when the fad wears off or a recession
appears. To play it safe—and perhaps finance your retirement—save your perfect-condition,
in- the-box Barbies, Hot Wheels, and Star Wars lightsabers.
Cost of Producing and Marketing the Product
Another profit consideration for marketers is to ensure that firms in their channels of
distribution make an adequate profit. Without profits for channel members, a marketer is cut
off from its customers. Figure 10.1 shows where the $200 a customer spends for a pair of
designer denim jeans goes: 50 percent of each dollar spent by a customer goes to a specialty
retailer to cover its costs and profit. The other 50 percent goes to the marketer (34 percent)
and manufacturers and suppliers (16 percent). So, the next time you buy a $200 pair of
designer denim jeans, remember that $100 goes to the specialty retailer that stocked,
displayed, and sold the jeans to you.
Cost of Changing Prices and Time Period They Apply
If Scandinavian Airlines asks General Electric (GE) to provide spare jet engines to
power the new Boeing 737 it just bought, GE can easily set a new price for the engines to
reflect its latest information since only one buyer has to be informed. But if Coldwater Creek
decides that sweater prices in its catalog are too low after thousands of catalogs have been
mailed to customers, it has a big problem. It must consider the cost of changing prices and
which prices apply to which time periods, as well as the cost of revising its price list and
reprinting and m ailing another edition of its catalog. However, for many of today‘s consumer
products, prices can change from minute to minute due to the transparency of prices afforded
by the Internet.
94
Figure 10.1
Cost of Producing and Marketing the Product
The text explains who gets the $200 you pay for your designer denim jeans.
Single Product versus a Product Line
When Apple introduced its iPhone in 2007, it was not only unique and in the introductory
stage of its product life cycle, but it was also the first commercially successful smartphone
sold. As a result, Apple had great latitude in setting and maintaining a premium price. However,
by mid- 2013, there was an onslaught of lower-cost rival smartphones, many of which were
powered by Google‘s Android operating system. At that time, Apple had a market share of
only about 15 percent of smartphone sales with its lone iPhone 5 model. Yet 48 percent of
Apple‘s sales revenues were tied to sales of its iPhones and related services. How should
Apple
How should Apple respond to this competitive pressure? Apple‘s CEO Tim Cook has
started to move away from the late Steve Jobs‘s strategy of having only a single model of a
product that is targeted at high-end users. An example is Apple‘s iPad mini, which was
introduced in October 2012 and broadened the iPad product line.
95
In late 2013, Apple launched the new iPhone 5S and the lower priced iPhone 5C to
broaden Apple‘s smartphone product line. The upside of this strategy is that it will increase
Apple‘s sales revenues if the new product reaches new smartphone buyers not willing to pay
the higher price of its iPhone 5S, which has more features. The downside: If that doesn‘t
happen, the new iPhone 5C could cannibalize sales from the higher-priced iPhone 5S and
reduce overall sales revenues.
Ethical Constraints on Pricing
Perhaps no other area of managerial activity is more difficult to depict accurately, assess
fairly, and prescribe realistically in terms of morality than the domain of price.This oft-quoted
assessment reflects the exceptional divergence of ethical opinions with respect to pricing.
Even among writers sympathetic to the need for profit, some consider it unethical to charge
different prices unless they reflect differences in costs, while others consider pricing unethical
unless prices are set ―equal or proportional to the benefit received.
This section is intended to help managers capture more of the value created by the
products and services they sell. In many cultures, and among many who promulgate ethical
principles, such a goal is morally reprehensible. Although this opinion was once held by the
majority, its popularity has generally declined over the past three centuries due to the success
of capitalism and the failure of collectivism to deliver an improvement in material well-being.
Still, many people, including many in business practice and education, believe that there are
legitimate ethical constraints on maximizing profit through pricing.
It is important to clarify your own and your customers' understanding of those standards
before ambiguous situations arises. The topology of ethical constraints in pricing illustrated in
is a good place to start. Readers should determine where to draw the line concerning ethical
constraints for themselves and their industry and determine as well how other people (family,
neighbors, social groups) might view such decisions.
Most people would reject the idea of zero ethical constraints, in which the seller can
dictate the price and terms and force them on an unwilling buyer. Sale of protection by
organized crime is universally condemned. The practice of forcing employees in a one-
company town to buy from the company store is subject to only marginally less condemnation.
Even when the government itself is the seller that is forcing people to purchase goods and
services at a price (tax rate) it sets, people generally condemn the transaction unless they feel
empowered to influence the terms. This level of ethical constraint was also used to condemn
the trusts that, before the antitrust laws, sometimes used reprehensible tactics to drive lower-
96
priced competitors out of business. By denying customers alternative products, trusts arguably
forced them to buy theirs.
Ethical level one embodied in all well-functioning, competitive market economies,

requires that all transactions be voluntary. Early capitalist economies, and some of the most
dynamic today (for instance, that of Hong Kong), condone any transaction that meets this
criterion. The legal principle of caveat emptor, Let the buyer beware, characterized nearly all
economic transactions in the United States prior to the twentieth century.
In such a market, people often make regrettable purchases (for example, expensive
brand- name watches that turn out to be cheap substitutes and stocks in overvalued
companies). On the other hand, without the high legal costs associated with meeting licensing,
branding, and disclosure requirements, new business opportunities abound even for the poor
making unemployment negligible.
Ethical level two imposes a more restrictive standard, condemning even voluntary
transactions by those who would profit from unequal information about the exchange. Selling
a used car without disclosing a known defect, concealing a known risk of using a product, or
misrepresenting the benefits achievable from a product are prime examples of transactions
that would be condemned by this ethical criterion.
Thus, many would condemn selling land in Florida at inflated prices to unwary out-of-
state buyers, or selling lottery tickets to the poor, since the seller could reasonably expect
these potential buyers to be ignorant of, or unable to process, information needed to make an
informed decision. Since sellers naturally know more about the features and benefits of
products than most consumers do, they may have an ethical duty to disclose what they know
completely and accurately.
Ethical level three imposes a still more stringent criterion: that sellers earn no more than
a fair profit from sales of necessities for which buyers have only limited alternatives. This
principle is often stated as follows: No one should profit from other people's adversity. Thus,
even nominally capitalist societies sometimes impose rent controls on housing and price
controls on pharmaceutical costs and physicians' fees. Even when this level of ethical
constraint is not codified into law, people who espouse it condemn those who raise the price
of ice during a power failure or the price of lumber following a hurricane, when the demand for
these products soars.
96
Ethical level four extends the criteria of ethical level three to all products, even those
with many substitutes and not usually thought of as necessities. Profit is morally justifiable
only when it is the minimum necessary to induce companies and individuals to make decisions
for the good of less-advantaged members of society. Profit is ethically justifiable only as the
price society must pay to induce suppliers of capital and skills to improve the well-being of
those less fortunate.
Profits from exploiting unique skills, great ideas, or exceptional efficiency (called
economic rents) are morally suspect in this scenario unless it can be shown that everyone, or
at least the most needy, benefits from allowing such profits to be earned, such as when a high
profit company nevertheless offers lower prices and better working conditions than its
competitors. Profits from speculation (buying low and selling high) are clearly condemned, as
is segmented pricing (charging customers different prices to capture different levels of value),
unless those prices actually reflect differences in cost.
Ethical level five is the most extreme constraint, is inconsistent with markets. In some
primitive societies, everyone is obliged to share good fortune with those in the tribe who are
less fortunate. From each according to his ability, to each according to his need‖ is the
espoused ethical premise of Marxist societies and even some respected moral philosophers.
Those that have actually tried to put it into practice, however, have eventually recoiled at
the brutality necessary to force essentially self-interested humans to give according to their
abilities‖ without reward. Within families and small, self-selected societies, however, this
ethical principle can thrive. Within social and religious organizations, members often work
together for their common good and share the results. Even within businesses, partnerships
are established to share, within defined bounds, each other's good and bad fortune.
For each level of ethical constraint on economic exchange, one must determine the
losses and gains, for both individuals and societies that will result from the restriction. What
effect does each level have on the material and social well-being of those who hold it as a
standard? Should the same standards be applied in different contexts? For example, is your
standard different for business markets than it is for consumer markets? Would your ethical
standards change when selling in a foreign country where local competitors generally hold a
higher or lower ethical standard than yours?
In assessing the standards that friends, business associates, and political

representatives apply, managers must ask themselves if their personal standards are the
same for their business as well as for their personal conduct. For example, would they
96
condemn an oil company for earning excess profits as a result of higher crude prices, yet
themselves take excess profits on a house that had appreciated substantially in a hot real
estate market? If so, are they hypocrites or is there some justification for holding individuals
and firms to different standards?
Although we certainly have our own beliefs about which of these ethical levels is practical
and desirable in dealing with others, and would apply different standards in different contexts,
we feel that neither we nor the people who claim to be experts on business ethics are qualified
to make these decisions for someone else. Each individual must make his or her own decisions
and live with the personal and social consequences.
Regardless of one's personal ethical beliefs about pricing, it would be foolish to ignore
the legal constraints on pricing. Antitrust law in the United States has developed over the
years to reflect both citizens' moral evaluations of companies' actions and companies' attempts
to get laws passed that protect them from more efficient or aggressive competitors. As the
summary below illustrates the meaning of these laws changes over time as courts respond to
changing social attitudes and the placement of judges with differing political views.

https://youtu.be/UFtnHdLYXqA?si=VDIBK9BDTj-acHCB
1. Identify and discuss the constraints that limit the range of prices.
2. Discuss the ethical constraints on pricing.
96
TOPIC 11 – LEGALITY OF PRICING POLICIES
OVERVIEW
Many nations regulate pricing in various ways. The most obvious controls relate to anti-
competitive actions. In the EU and the United States, firms cannot collude to set prices and
these kinds of laws are widely enacted although intermittently enforced in various other
markets throughout the world. In the United States, a manufacturer must generally treat each
class of customer equally. That is, the customer who buys a particular quantity of product
should receive the same discount as another customer buying that same quantity.
However, some exceptions to this rule are allowed. Manufacturers can use
discriminatory pricing to meet a competitive threat in a particular market or if it can be proved
that their costs to serve one customer are lower than another.
In setting international prices, another important issue is that of dumping. Dumping

simply means that a product is sold in a particular market at a level less than its cost of
production plus a reasonable profit margin. Anti-dumping penalties have increased in the
United States, the EU, Canada, and Australia and this will continue to be a key issue in
international marketing. Managers must be careful that their pricing decisions can be
defended against anti-dumping accusations.
LEARNING OUTCOMES

• Explain the concept of transfer pricing and competitive bidding.
• Discuss the transfer pricing methods.
• Understand the competitive bidding.
COURSE MATERIALS
TOPIC 11 – LEGALITY OF PRICING POLICIES

• Transfer Pricing
• Competitive Bidding
TRANSFER PRICING
Transfer pricing can have an important effect on pricing decisions. Transfer prices are
those set for goods or services which are bought by one division of a firm from another
division. These are inside or intra-corporate prices.
Transfer prices also refer to the terms and conditions which so-called “associated
enterprises” agree for their “controlled transactions.” Examples of such transactions are the
provision of management services, the supply of goods and the provision of loans.
According to this widely used OECD Transfer Pricing Guidelines (OECD) definition,
enterprises are associated if:
a. an enterprise participates directly or indirectly in the management, control or capital

of another enterprise or (b) the same persons participate directly or indirectly in the
management, control or capital of two enterprises.
Now we know the concept of associated enterprises. The following example shows
this practice in a graph:
Figure 11.1
Practice of Associated Enterprises
In the picture you see that Enterprise X manufactures pianos in Malaysia. Enterprise Y
distributes these from Hong Kong. Both X and Y are 100% owned by Enterprise Z. Because
Z participates directly in the capital of both X and Y, they are all associated enterprises.
When selling pianos on the market, Z has no control on the price at which one piano is
sold. Reason is that prices are set by supply and demand. Currently, the market price for one
piano is USD 5,000. However, Z does control any transactions between X and Y.
Therefore, the internal sale of a piano by X to Y is called a ―controlled transaction.

The price charged for this transaction is what is called a transfer price.
Why Are Transfer Prices Important?
Let‘s go back to the Figure 11.1
The price at which one piano is sold by X to Y affects their individual financial results
(remember: this is the controlled transaction). If X charges a high price, X makes more profit.
If X charges a low price, Y makes more profit.
From a commercial perspective, the price doesn‘t matter. The financial results of X and
Y are consolidated. For shareholder Z, it doesn‘t matter which of the two companies makes
the profit. However, from a tax perspective it does matter.
X is taxed in Malaysia and Y is taxed in Hong Kong. The corporate tax rate in Hong Kong
is 16.5%. In Malaysia, it is 25%. Z wants to see as much profit after tax as possible. Z can use
its influence as a shareholder to set the prices in such a way that the profits are highest where
taxes are lowest.
How Transfer Prices Work
A transfer price arises for accounting purposes when related parties, such as divisions
within a company or a company and its subsidiary, report their own profits. When these related
parties are required to transact with each other, a transfer price is used to determine costs.
Transfer prices generally do not differ much from the market price. If the price does differ, then
one of the entities is at a disadvantage and would ultimately start buying from the market to
get a better price.
For example, assume entity A and entity B are two unique segments of Company ABC.
Entity A builds and sells wheels, and entity B assembles and sells bicycles. Entity A may also
sell wheels to entity B through an intra-company transaction. If entity A offers entity B a rate
lower than market value, entity B will have a lower cost of goods sold (COGS) and higher
earnings than it otherwise would have. However, doing so would also hurt entity A's sales
revenue.
If, on the other hand, entity A offers entity B a rate higher than market value, then entity
A would have higher sales revenue than it would have if it sold to an external customer. Entity
B would have higher COGS and lower profits. In either situation, one entity benefits while the
other is hurt by a transfer price that varies from market value.
Regulations on transfer pricing ensure the fairness and accuracy of transfer pricing
among related entities. Regulations enforce an arm‘s length transaction rule that states that
companies must establish pricing based on similar transactions done between unrelated
parties. It is closely monitored within a company‘s financial reporting.
Transfer pricing requires strict documentation that is included in the footnotes to the
financial statements for review by auditors, regulators, and investors. This documentation is
closely scrutinized. If inappropriately documented, it can burden the company with added
taxation or restatement fees. These prices are closely checked for accuracy to ensure that
profits are booked appropriately within arm's length pricing methods and associated taxes are
paid accordingly.
Transfer Pricing Methods
Transfer pricing methods (or methodologies) are used to calculate or test the arm‘s
length nature of prices or profits. Transfer pricing methods are ways of establishing arm‘s
length prices or profits from transactions between associated enterprises. The transaction
between related enterprises for which an arm‘s length price is to be established is referred
to as the controlled transaction‖. The application of transfer pricing methods helps assure
that transactions conform to the arm‘s length standard.
The good thing about transfer pricing is that the principles and practices are quite similar
all around the world. The OECD Transfer Pricing Guidelines (OECD Guidelines) provide
five common transfer pricing methods that are accepted by nearly all tax authorities.
The five transfer pricing methods are divided in to two general categories of methods
traditional transaction methods and transactional profit methods.
1. Traditional Transaction Methods measure terms and conditions of actual

transactions between independent enterprises and compares these with those of a
controlled transaction. This comparison can be made on the basis of direct measures
such as the price of a transaction but also on the basis of indirect measures such as
gross margins realized on particular transactions.
2. Transactional Profit Methods don‘t measure the terms and conditions of actual
transactions. In fact, these methods measure the net operating profits realized from
controlled transactions and compare that profit level to the profit level realized by
independent enterprises that are engaged in comparable transactions. The
transactional profit methods are less precise than the traditional transaction methods,
but much more often applied. The reason is that application of the traditional transaction
methods, which is preferred, requires detailed information and in practice this
information is not easy to find.
In short:
• Traditional transaction methods rely on actual transactions.
• Traditional profits method relies on profit levels.
The Five Transfer Pricing Methods
As mentioned, the OECD Guidelines discuss five transfer pricing methods that may be
used to examine the arm‘s-length nature of controlled transactions. Three of these methods
are traditional transaction methods, while the remaining two are transactional profit methods.
We list the methods here.
Traditional transaction methods

1. CUP method
2. Resale price method

3. Cost plus method
Transactional profit methods

1. Transactional net margin method (TNMM)
2. Transactional profit split method.
Figure 11.2
Transfer Pricing Methods
There are five basic methods for establishing transfer prices outlined in the OECD guidelines:
COMPARABLE UNCONTROLLED PRICE (CUP) METHOD
The Comparable Uncontrolled Price (CUP) Method compares the terms and conditions
(including the price) of a controlled transaction to those of a third party transaction. There are
two kinds of third party transactions.
a. Firstly, a transaction between the taxpayer and an independent enterprise (Internal

Cup).
b. Secondly, a transaction between two independent enterprises (External Cup).
The below example shows the difference between the two types of CUP Methods:
Figure 11.3
Comparable
Uncontrolled
Price
(CUP) Method
CUP Method Example
An example of the application of the CUP method:
A manufacturing company (X) manufactures the “Buster 3.0.” This is a high-quality

vacuum cleaner. It is up to 10 times stronger than the models of most competitors. The only
competing manufacturer that can provide a vacuum cleaner performing similarly is the Dust
Company, with its renowned “Dragon Buster.” X and Z sell their vacuum cleaners via both
associated and third party distributors. X and Y operate completely similar.
Now say that X has received an order from distribution company Y for the supply of 1 Buster
3.0. X and Y have the same shareholder (Z). X wonders what transfer price it should apply.
This means that X should find the terms and conditions (here: the price) of a comparable
transaction. Under the CUP method, there are now 2 options:
1. X looks at the price for which it sells 1 “Buster 3.0” to a third party distributor
(Internal CUP).
2. X looks at the price for which Z sells 1 “Dragon Buster” to a third party distributor
(External CUP).
Obviously, option 1 is the easy option here and would be acceptable. But option 2 would
also be acceptable and provides a better defense towards tax authorities (because “X is doing
what an independent enterprise does”).
this case:
The below example summarizes the use of the CUP Method in
Figure 11.4
Comparable Uncontrolled Price
(CUP) Method Example
Use of CUP Method in Practice
The CUP method is the most direct and reliable way to apply the arm‘s length principle
to a controlled transaction. However, it is often difficult to find a transaction that is sufficiently
comparable to a controlled transaction. Therefore, this method is used when there is a lot of
available data.
In practice, the CUP method is often used for financial transactions such as group loans.
For these types of transactions there is a lot of data available and market standards help
determine terms and conditions. For example, most banks work with the same formulas to
determine credit ratings of borrowers. This serves as a basis for the interest rate of a loan.
This method is also often used to determine prices of intellectual property (IP) charged for the
use of brands and licenses.
The CUP Method with Example – Conclusion
The CUP Method is one of the 5 common transfer pricing methods provided by the OECD
Guidelines. It compares the terms and conditions (including the price) of a controlled
transaction to those of a third party transaction. The CUP Method is the most direct and reliable
way to apply the arm‘s length principle to a controlled transaction. But, in practice it is often
difficult to find sufficiently comparable transactions. The method is often applied to financial
and IP transactions.
THE RESALE PRICE METHOD
The Resale Price Method is also known as the ―Resale Minus Method.‖ As a starting
position, it takes the price at which an associated enterprise sells a product to a third party.
This price is called a resale price.
Then, the resale price is reduced with a gross margin (the resale price margin),
determined by comparing gross margins in comparable uncontrolled transactions. After this,
the costs associated with the purchase of the product, like custom duties, are deducted. What
is left, can be regarded as an arm‘s length price for the controlled transaction between
associated enterprises.
The below image is an example of the Resale Price Method:

Figure 11.5
Resale Price Method Example
Resale Price Method Example
With the above image in mind, let‘s look at a Resale Price Method example:
Apple & Pear, based in Hong Kong, brews a very exclusive non-alcoholic beverage
called “the Mountain.” It sells this beverage to high-end nightclubs around Asia via associated
distributors. The market price for one can of “the Mountain” is USD 100. Apple & Pear does
not sell the beverage to independent distributors. Also, there is no company in Asia that brews
a comparable beverage.
However, there are comparable distributors that sell “the Vulcano.” This is a competing
alcoholic beverage brewed by Gin & Juice, a company also based in Hong Kong. The market
price for one bottle of “the Vulcano” is USD 100. In addition, distributors report USD 5 gross
margin per bottle sold with 2 USD on custom duties.
Apple & Pear wants to set the transfer price for the supply of “the Mountain” to the
associated distributors. There is no Internal Cup (no third party transactions by Apple & Pear)
or External Cup (no comparable transactions). Therefore, the CUP method can’t be applied
here (The CUP Method with example).
In our example, the distributors of “the Vulcano” are comparable to the distributors of “the
Mountain.” The result is that the gross margin and custom duties reported can be used as
input for the Resale Price Method.
This would look as follows:
In this example, when using the Resale Price Method, Apple & Pear needs to charge a
transfer price of 93 USD to its associated distributors.
Use of Resale Price Method in practice
The Resale Price Method requires that third party transactions are comparable with the
controlled transaction. As a result, there can be no differences that have a material effect on
the resale price margin. Because each transaction is unique, it is quite difficult to meet this
requirement.
Therefore, the Resale Price Method is not often used.
However, in case sufficient comparable transactions are available the Resale Price
Method can be useful to determine transfer prices. The reason is that in such a case, third
party sales prices are easily found.
Resale Price Method with Example – Conclusion
The Resale Price Method is one of the 5 common transfer pricing methods provided by
the OECD Guidelines. First of all, it takes as a starting position the price at which an
associated enterprise sells a product to a third party (the ―resale price‖). It then reduces this
price with a gross margin (the ―resale price margin‖). This margin is determined by comparing
gross margins in comparable uncontrolled transactions.
The Resale Price Method is not often used. The reason is that it is difficult to find
comparable transactions. However, in case those can be found, the Resale Price Method is
suitable to examine gross margins of associated enterprises engaged in sales and distribution
to third parties.
THE COST PLUS METHOD
The Cost Plus Method compares gross profits to the cost of sales.
Under the Cost Plus Method, the first step is to determine the costs incurred by the
supplier in a controlled transaction for products transferred to an associated purchaser.
Secondly, an appropriate mark-up has to be added to this cost, to make an appropriate profit
in light of the functions performed. After adding this (market-based) mark-up to these costs, a
price can be considered at arm‘s length.
The application of the Cost Plus Method requires the identification of a mark-up on costs
applied for comparable transactions between independent enterprises. An arm‘s length mark-
up can be determined based on the mark-up applied on comparable transactions among
independent enterprises.
It is explained in this figure:
Figure 11.6 Cost Plus

Method
Cots Plus Method Example
With this in mind, let‘s look at an example of the application of the Cost Plus Method:
Candy Casing (X) manufactures Iphone cases for associated enterprises. There are
many companies around that manufacture Iphone cases, including independent enterprise Ali
Accessories (B). B and X manufacture similar Iphone cases.
Now say that X is asked by associated enterprise Y to manufacture 100,000 Iphone

cases. X wonders what transfer price it should charge. This means that X should find the
terms and conditions (here: the price) of a comparable transaction. Under the Cost Plus
Method, X should then first compare its cost base with the cost base of B when manufacturing
100,000 Iphone cases for a third party client.
Provided that the cost base is comparable, the next step is to identify the mark-up on
costs applied by B. That mark-up should be added to the cost by X. The result is the arm’s
length price.
The below image illustrates this example:
Figure 11.7
Cost Plus Method Example
Use of Cost Plus Method in Practice
The Cost Plus Method can be helpful to assess the arm‘s length remuneration of low-
risk, routine-like activities. An example of such activities is contract manufacturing, where
there is a manufacturing enterprise which contracts exclusively with one client (principal) and
assumes limited risks. A lot of car producing MNEs operate under that model. Another
example is the provision of simple administrative services.
The downside of the Cost-Plus Method is that it requires controlled and uncontrolled
transactions to be highly comparable. To establish such level of comparability, detailed
information on the transactions should be available. Examples are the types of products
manufactured, actual activities, cost structures and the use of intangible assets. In case this
information is unavailable, the Cost-Plus Method cannot be applied.
In practice this makes that the Cost-Plus Method is not often used.
Conclusion
The Cost-Plus Method is one of the 5 common transfer pricing methods provided by the
OECD Guidelines. The Cost-Plus Method is a traditional transaction method. The Cost-Plus
Method compares gross profits to the cost of sales. Firstly, you determine the costs incurred
by the supplier in a controlled transaction. An appropriate mark-up has to be added to this
cost to achieve the correct transfer price. The Cost-Plus Method is often applied to low-risk
routine-like activities such as manufacturing. In practice, it is often difficult to find information
on sufficiently comparable transactions.
THE TRANSACTIONAL NET MARGIN METHOD (TNMM)
The Transactional Net Margin Method (TNMM) recently emerged as a favored model
for many multinationals because transfer pricing is based on net profit as opposed to
comparable external market pricing. The CUP, Resale Price Methods, and Cost-Plus-
Percentage are all based on the actual cost of comparable goods or services for external
transactions. TNMM instead compares net profit margin earned in a controlled intercompany
transaction to the net profit margin earned by a similar transaction with a third party. It can
also look at the net margin earned by a third party on a comparable transaction with another
third party.
With the TNMM, you need to determine the net profit of a controlled transaction of an
associated enterprise (tested party). This net profit is then compared to the net profit realized
by comparable uncontrolled transactions of independent enterprises.
As opposed to other transfer pricing methods, the TNMM requires transactions to be

broadly similar‖ to qualify as comparable. Broadly similar in this context means that the compared
transactions don‘t have to be exactly like the controlled transaction. This increases the amount of
situations where the TNMM can be used.
A comparable uncontrolled transaction can be between an associated enterprise and an

independent enterprise (internal comparable) and between two independent enterprises
(external comparables).
Let‘s see how this looks in this example:

Figure 11.8
Transactional Net Margin Method
(TNMM) Example
TNMM‟s Key Element: The Net Profit Indicator
The most important aspect of the TNMM is the ―net profit indicator.
This is a ratio of net profit relative to a base, such as costs, sales or assets. The net profit
indicator that a taxpayer realizes from a controlled transaction is compared with the net profit
earned in comparable uncontrolled transactions.
We will now explain two examples of commonly used net profit indicators: the Net Cost-
Plus Margin and the Net Resale Minus Margin.
TNMM I: Net Cost-Plus Margin
The Net Cost-Plus Margin is the ratio of operating profit to total cost.
As Operating profit‖ usually Earnings before Interest and Taxes is used, or simply
EBIT. Total cost means the direct and indirect operational costs without extraordinary items.
The Net Cost-Plus Margin basically measures the return on total costs of a company. By
using this ratio, the comparison eliminates differences resulting from categorizing costs. An
example is costs that can be either qualified as costs of goods sold or operating costs. This net
comparison is not allowed under the traditional transactions method Cost-Plus Method. That
method uses information on gross level (and thus requires costs to be categorized properly).
If the TNMM uses the Net Cost-Plus Margin as net profit indicator, one often refers to it
simply as the Net Cost-Plus Method.
This method is often used for low-risk routine-like activities such as manufacturing and
provision of administrative support services.
With this in mind, let‘s look at an example.
Example Net Cost Plus Margin
Company X provides administrative support services such as invoicing and bookkeeping.

Associated enterprise Y asks X to provide invoicing services. Y thinks that they need about
1.000 hours of such services.
X knows that the total cost of 1.000 hour of services is 125.000 USD. X wonders what
transfer price it has to charge. This means that X should find the terms and conditions (here:
the price) of a comparable transaction.
There are many companies around that provide comparable services, including
independent Enterprise B. X and B have exactly the same business model. Company X can
look at Enterprise B to determine a good arm’s length price.
How to determine this price? As mentioned, first we need to find the ratio of operating
profit to total cost.
The second step is to use the Net Cost-Plus Margin to calculate the arm’s length transfer
price. To calculate the transfer price one simply has to add the Net Cost-Plus Margin to the
existing total cost.
We saw that the total cost of the services is 125,000 USD. If we add to that amount the
Net Cost-Plus Margin of 0.25 (31,250 USD) we end up with a transfer price of 156,250 USD (or
156.25 USD per hour).
TNMM II: Net Resale Minus Margin
The Net Resale Minus Margin is the ratio of EBIT to turnover. It basically measures the
return on sales of a company.
By using this net ratio, the comparison eliminates differences resulting from categorizing
sales under sales revenues or other revenues. This is not allowed under the traditional
transactions method Resale Minus as that method uses information on gross sales level (and
thus requires a detailed specification).
If the TNMM uses the Net Resale Minus Margin as net profit indicator, one often refers
to it as the Net Resale Minus Method. This method is often used for sales and distribution
activities.
With this in mind, let‘s look at an example.
Example Net Resale Minus Method
Company X provides distribution services. Associated enterprise Y asks X to provide

distribution services. This means that X should find the terms and conditions (here: the price)
of a comparable transaction.
There are many companies around that provide comparable services, including
independent Enterprise B. X and B have exactly the same business model. Company X can
look at Enterprise B to determine a good arm’s length price.
How to determine this price? As mentioned, first we need to find the ratio of EBIT to turnover.
The second step is to calculate the arm’s length transfer price. For this, you simply charge a
price at which the Net Cost Plus Margin is not less or more than 0.15.
The Transactional Net Margin Method In practice
The TNMM is a good alternative for the traditional transactions methods. The fact that
multiple forms of net profit indicators can be used, makes this method widely applicable. It is
therefore not a surprise, that this is the most used transfer pricing method.
The TNMM can be helpful to assess the arm‘s length remuneration of both low-risk
routine- like manufacturing and services and more complicated functions like sales or
distribution. The downside of the use of the TNMM is that the level of comparability of
independent transactions in some cases can be questioned. This point is often brought
forward by tax authorities. However, the fact is that the TNMM is often used exactly because
other transfer pricing methods cannot be applied because of a lack of comparability and / or
information in the first place.
Conclusion
The Transactional Net Margin Method is one of the 5 common transfer pricing methods
provided by the OECD Guidelines. It is a transactional profit method.
The TNMM compares the net profit realized in a controlled transaction to the net profit
realized by broadly similar independent enterprises in similar transactions. The TNMM makes
use of a ―net profit indicator‖ as a means for this comparison. This is a ratio of net profit
relative to a base, such as ―costs,‖ ―sales‖ or ―assets.‖ The TNMM is the most used
transfer pricing method. It is used for both low-risk routine-like manufacturing and services and
more complicated functions like sales or distribution.
THE PROFIT SPLIT METHOD
Associated enterprises sometimes engage in transactions that are very interrelated.

Therefore, they cannot be examined on a separate basis. For these types of transactions,
associated enterprises normally agree to split the profits.
The Profit Split Method examines the terms and conditions of these types of controlled
transactions by determining the division of profits that independent enterprises would have
realized from engaging in those transactions.
An example of this method is shown in this image:
Figure 11.9
Profit Split Method Example
In the above example, we see two comparable joint ventures. Joint Venture I is owned
by associated enterprises Y and X. Opposite to that, Joint Venture II is owned by independent
enterprises A and B.
Let’s say that we need to determine the transfer prices to be charged for the transactions
related to Joint Venture I.
For that, we can compare the terms and conditions of the controlled transactions by
determining the division of profits of comparable uncontrolled transactions. In this example,
this means that we can compare Profit Split I with Profit Split II.
Two Kinds of Profit Split Methods
There are two kinds of Profit Split Methods:

1. Contribution profit split method;
2. Residual profit split method.
The contribution profit split method splits profit among associated enterprises
according to the functions performed and risks assumed. In addition, the assets are analyzed
which are contributed by each entity. In particular, intangible assets.
The application of the contribution profit split method requires careful analysis. First of all
of the functions performed, risks borne and assets used by each associated enterprise. In
addition, the allocation of cost, expense, earnings, and capital of the associated enterprises
involved in the transaction needs to be measured.
The residual profit split method requires the identification of the routine profit for an
entity as a first step. Any remaining profit is then split based on each party‘s contribution to th
e earning of the non-routine profit, for example the ownership of intangibles.
Use of Profit Split Method in Practice
The Profit Split Method is usually applied in cases where the controlled transaction is
highly integrated. This makes it difficult to evaluate the operating result separately. Examples
are the set-up of a partnership or the joint exploitation of intangible assets such as brands.
This method is not often used in practice, but is rising in popularity. It‘s main benefit is
that it looks at profit allocation in a mere holistic way rather than on a transactional basis. This
can be appropriate for cases where there are multiple controlled transactions instead of one
clearly identifiable controlled transaction.
There is an important downside to the Profit Split Method. Due to the subjective profit
allocation criteria based on score cards, it can offer tax authorities the possibility to allocate a
disproportionate amount of profits to an associated enterprise engaging in a particular
transaction. This could lead to a non-arm‘s length outcome and disputes with the tax
authorities.
Conclusion
The Profit Split Method is one of the 5 common transfer pricing methods provided by the
OECD Guidelines. It is a transactional profit method.
The Profit Split Method measures the net operating profits realized from controlled
transactions and compares the profit level to the profit level realized by comparable
independent enterprises that are engaged in comparable transactions.
There are two kinds of Profit Split Methods: (1) contribution profit split method; and
(2) residual profit split method.
The Profit Split Method is not often used in practice but is rising in popularity. Especially
in cases where the controlled transaction is highly integrated, it can be a very useful transfer
pricing method. However, there are also important downsides, one being the risk of disputes
with tax authorities.
Transfer Pricing Policy
Companies often spend a lot of time and money to analyze and document their transfer
pricing arrangements. But proper implementation is equally important.
A transfer pricing policy ensures that everyone within the firm is ―on the same page.‖
Moreover, it demonstrates that transfer pricing has been considered and implemented
correctly, creating a record for internal and external stakeholders.
These days, Multi National Enterprises (MNEs) operate internal policies for almost
everything. Such PDF documents formalize guidelines and protocols in specific areas, ranging
from employment policies to risk management.
A transfer pricing policy is similar. It laws down the MNEs policy regarding the
application and implementation of transfer pricing rules. It can concern one or more
intercompany transactions.
It spells out for different departments what they need to do and how they need to do it.
Moreover, it helps the tax/finance department to ensure correct pricing.
The Objective of a Transfer Pricing Policy
The objective of transfer pricing policies is two-fold:
1. Harmony. Ensure that everyone in the firm is ―on the same page‖ when it comes to
the transfer pricing arrangements. Successful implementation of transfer pricing only
works if there is ―buy-in‖ from stakeholders. Before becoming reality, it needs to be
understood.
Example I: The finance department wants to know what amounts to charge to which group
entity (and when), the risk department wants to ensure that transfer pricing
arrangements do not create risks, and the manager wants to know whether his/her
financial results are affected.
2. Compliance. Demonstrate towards tax authorities that transfer pricing has been
considered and implemented the right way. It shows a proactive attitude which is highly
appreciated by tax authorities. It sets you apart from the crowd.
Example II: During a tax audit, tax authorities normally check whether compliance
documentation requirements are met. Besides showing the customary 100-page transfer
pricing report, it is powerful if a MNE can show exactly how the transfer pricing
arrangements have been implemented and are being complied with.
COMPETITIVE BIDDING
Business to business (B2B) sales are often completed through competitive bids. This is
especially true for government institutions and non-profits such as hospitals. Some non-
governmental firms also use competitive bids.
In some cases, a firm may require a bid to a particular specification and then reserve the
right to negotiate further with the winning bidder. Firms use specification buying especially for
large projects. These firms develop detailed specifications based on the performance or
description of a particular product or service or a combination of both. Firms supplying products
or services to the military or large power plants or other major projects need to develop an
expertise not only in the bidding process, but also in the specification process.
“Specmanship” means a firm‘s sales force is expert at helping a customer develop

specifications which will limit the bidders. The most successful salespeople can develop
specifications with requirements that can be met only by their firm. When faced with a potential
competitive bidding situation based on specifications to be developed by a large customer, it
is necessary to spend the required time to influence the design of the specifications to ensure
the most favorable specifications possible before bidding documents are released. A
successful solutions marketing requires a supplying firm to develop a unique offering
It takes as much work to develop a competitive bid as to create a business plan. It is not
unusual for a firm to spend well over €100,000 to complete the analysis required to provide
responsive bids to a particular customer. Before a firm decides to take on this major effort, a
screening procedure should be completed. Table 10.6 shows a procedure for evaluating bid
opportunities.
In this procedure, eight pre-bid factors should be examined. These factors are shown
in Table 11.1. An analysis tool can be used to assign a weight to each factor and then rate the
firm‘s capability for this particular bid. Multiplying the weights by the ratings gives a value fo r
each factor and adding all of the values together gives the firm some idea of whether they
should pursue this particular bid. Of course if there are other opportunities, these can be
compared using this same tool.
Table 11.1 Evaluating Bid Opportunities
The factors include plant capacity. The firm must consider whether winning this bid will
place an unusual strain on the plant required to make the product or whether the plant is
running at a relatively low level and can use additional work. Competition must be considered
as well, both in terms of the number of competitors and their possible bids. Past experience
with competitors will serve as a guide here.
A third and most important area is the possibility for follow-up opportunities. In some
cases, a firm winning a bid will be placed on a preferred supplier list (such as with a
government) and many additional orders may follow. In addition, a firm may receive orders for
associated products or services. Here, the marketer must be careful because many
sophisticated purchasers will indicate a large follow-up to a particular order with the goal of
pushing the supplier to reduce the initial price.
The next factor is quantity. Obviously, a very large order is more attractive than a smaller
one. Large orders for standard product with the same features are more attractive than an
order for a mix of product. If the quantity can create economies of scale for a supplier, it will
be more attractive than one which simply pushes a supplier past a point of diminishing returns.
Delivery is a key consideration as well. In some cases, a large quantity of product is

required to be delivered all at once. This may put an undue strain on the manufacturer‘s
facilities. Another important consideration is the effect of accepting this order on other
customers, both from a delivery and plant capacity point of view. If a large order has the
potential of reducing the manufacturer‘s capability to satisfy loyal customers in the future, it
may not be as attractive.
Obviously, profit is critical in deciding whether or not to move ahead. While this analysis
must take place before final prices are determined, a general idea of the prices required to
gain this order should be employed so that the firm can make an estimate of the possible profit
to be realized. In some cases, a firm may decide that profit is not the overriding concern and
that in order to fill the plant it will move ahead with a relative unprofitable bid.
Another key factor is experience. As has been said, developing a winning bid for a
particular project may take as much effort as an entire business plan for a new venture. If the
firm has experience in developing bids of this particular kind, it should be looked upon more
favorably.
Finally, the bid capability means the availability of people and financial resources to
actually complete the work. There may be times when the firm simply does not have the
capability to do the required work and therefore the project becomes less attractive.
Internationally, insisting on competitive bidding can be a problem in a high-context

culture, where the project will probably be given to the firm the buyers feel is best positioned to
do it based on the past establishment of trust. However, in a low-context culture a firm would
develop specifications and push the supplier to meet the specifications as written (Hall, 1976).

https://youtu.be/DG3awJwvIKg?si=0hrYfj-CBppfAt-Y
https://youtu.be/3vjph98hThc?si=IwjCtNuZz8Ymxmnp
https://youtu.be/gq33jYxHMzs?si=84lS7xQ596IesQ3i
1. What is transfer pricing? Define in your own words.
2. List and discuss the five transfer pricing methods.
3. Identify and discuss the eight pre-bid factors.
4. When a firm enters a competitive bidding situation, how might they analyze
the attractiveness of entering a particular bid? Explain.
REFERENCES
Alan Zimmerman and Jim Blythe. Business to Business Marketing Management: A Global
Perspective 2nd Edition Routledge 2013 ISBN: 978-0-203-06758-1
5 of the Best Penetration Pricing Examples. Retrieved from
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7 international pricing constraints every exporter needs to consider (2017).
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for-exporters.html
Brian Beck (2020). Pricing Strategies to Manage Channel Conflict in B2B Commerce.
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manage-channel- conflict-b2b-commerce
Characteristics of Pure Competition Market System. Retrieved from
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characteristics/
David L. Kurtz. Contemporary Marketing 15th Edition South-Western Cengage Learning
ISBN- 13: 978-1-111-22178-2
Ethical Constraints on Pricing. Retrieved from http://theorybiz.com/the-strategy-and-
tactics-of- pricing/ethics-and-the-law/1817-ethical-constraints-on-pricing.html
Francesca Nicasio (2015). How to Price Across Multiple Channels: What Retailers Need
to Know About Modern Pricing Policies. Retrieved from
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modern-pricing-policies/
Kyle Poyar (2020). Netflix Quietly Perfected Their Pricing. Here‘s What You Can Learn.
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strategy/#.XzZ3legzaM8
John Kirk (2013). Android‘s Penetration vs. Apple‘s Skimming Marketing Strategies.
Retrieved from https://techpinions.com/androidss-penetration-vs-apples-skimming-
marketing- strategies/15255
John O'Rourke. Transfer pricing: A primer. Retrieved
from https://www.accountingtoday.com/opinion/transfer-pricing-methods-best-
practices-and- business-benefits
Kerin, Theng, Hartley, Rudelius (2013) Marketing in Twelfth Edition McGraw-Hill
Education, New York ISBN 978-1-259-00789-7
Lamb, Hair, McDaniel (2011) Marketing 11th Edition
Matt Ellsworth (2019). Captive Product Pricing Explained: Definition and Examples.
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definition-and-examples/
Maximillian Claessens (2015). Price Adjustment Strategies - Adjusting Prices for
Different Markets. Retrieved from https://marketing-insider.eu/price-adjustment-
strategies/
Moira McCormick (2016). How To Convince Price Sensitive Customers To Spend
Their Money. Retrieved from https://blog.blackcurve.com/how-to-convince-price-
sensitive-customers-to- spend-their-money
Moira McCormick (2016). Pricing Changes: The Good, the Bad, the Ugly.
Retrieved from https://blog.blackcurve.com/pricing-changes-the-good-the-
bad-the-ugly
Pratiti Soumya (2017). How To Overcome Price Sensitivity of Consumers.
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price-sensitivity-of- consumers-e6e221fc2dcf
Patrick Campbell (2020). Product Line Pricing Examples, Definitions, and Strategies.
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Perfect Competition, Monopolistic Competition, Oligopoly, and Pure Monopoly.
Retrieved from https://analystprep.com/cfa-level-1-exam/economics/perfect-
competition-monopolistic- competition-oligopoly-and-pure-monopoly/
PhilipKotler and Gary Armstrong (2013) Principles of Marketing 14th Edition, Pearson
Education Limited, England ISBN 978-0-273779827
PhilipKotler, Veronica Wong, John Saunders and Gary Armstrong (2013) Principles of
Marketing 14th Edition, Pearson Education Limited, ISBN 978-0-273-68456-5
Public Policies and Pricing Strategies. Retrieved from
https://darketyler.wordpress.com/reflection-essays-1-2/reflection-essays-
2/category-9/
Pure Monopoly and Monopoly Power. Retrieved from
https://www.tutor2u.net/economics/reference/pure-monopoly-and-monopoly-
power
Sean King (2020). The Impact of Using Transfer Pricing in Multistate Transactions
Transfer Pricing Asia (2017). What is Transfer Pricing? | A Clear and Complete Definition.
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Transfer Pricing Asia (2017). Five Transfer Pricing Methods with Examples.
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methods-examples/
Transfer Pricing Asia (2017). What is a Transfer Pricing Policy? | Stay One Step Ahead.
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Tucker Dawson (2020). How Starbucks uses Pricing Strategy for Profit Maximization.
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uses-pricing- strategy-for-profit-maximization
Ty Montague (2013). If You Want to Raise Prices, Tell a Better Story.
Retrieved from https://hbr.org/2013/07/want-to-raise-prices-tell-a-be

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POLYTECHNIC UNIVERSITY

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SHARED VALUES AND PRINCIPLES

INSTITUTIONAL LEARNING OUTCOMES (ILOS)

As a polytechnic state university, PUP shall develop its students to possess:

2. Effective Communication. Graduates apply the four macro skills in communication

3. Strong Service Orientation. Graduates exemplify strong commitment to service

4. Adept and Responsible Use or Development of Technology. Graduates demonstrate

6. Leadership and Organizational Skills. Graduates assume leadership roles and

7. Personal and Professional Ethics. Graduates manifest integrity and adherence to

9. National and Global Responsiveness. Graduates exhibit a deep sense of nationalism as

PROGRAM LEARNING OUTCOMES (PLOS)

COURSE LEARNING OUTCOMES (CLOS).

At the end of this course, the students are expected to:

Lesson 2 – Pricing Strategies 32

Lesson 3 – New Product Pricing Strategies 46

Lesson 4 – Product Mix Pricing Strategies 55

Lesson 6 – Pricing Under Various Market Condition 71

Lesson 7 – Public Policy and Marketing 77

Lesson 8 – Determining Demand – Customer Perception of Price 84

Lesson 9 – Price Changes 92

Lesson 10 – Identifying Pricing Constraints 98

Reference List 130

At the end of the semester, the student will be able to:

• Understand the nature of price and pricing strategy.

• Gain insights on pricing under various market conditions.

• Appreciate the policies of pricing in our economic development.

• Uphold Filipino values in the practice of marketing.

After successful completion of this module, you should be able to:

TOPIC 1 – INTRODUCTION TO PRICE

The Price Equation

Price as an Indicator of Value

Value = Perceived benefits

Price in the Marketing Mix

Profit = Total revenue - Total cost

The Importance of Price

Value Is Based upon Perceived Satisfaction: Consumers are interested in obtaining a

The Importance of Price to Marketing Managers

Price × Units = Revenue

In the organizational market, where customers include both governments and

To survive in today‘s highly competitive marketplace, companies need pricing objectives

Profit-Oriented Pricing Objectives

Profit-oriented pricing objectives include profit maximization, satisfactory profits, and

Sales-Oriented Pricing Objectives

Two Ways to Measure Market Share (Units and Revenue)

Many companies believe that maintaining or increasing market share is an indicator of

Management‘s task when using this objective is to calculate which price–quantity

Status Quo Pricing Objectives

Steps in Setting the Right Price on a Product

Establish Pricing Goals

Choose a Price Strategy to help determine a Base Price

A successful skimming strategy enables management to recover its product

A penetration strategy tends to be effective in a price-sensitive market. Price should

The big advantage of penetration pricing is that it typically discourages or blocks

Tactics for Fine-Tuning the Base Price

a. Discounts, Allowances, Rebates, and Value-Based Pricing

c. Other Pricing Tactics

• Leader Pricing (or loss-leader pricing) is an attempt by the marketing manager to

Link to reference video lesson: