Consumer Behavior and Pricing Strategy

By Peter, J.P., Olson, J.C.

Edited by Paul Ducham

MONEY

As we have noted, most pricing research has focused only on money: the dollar amount a consumer must spend to purchase a product or service. This research has recognized that the same dollar amount may be perceived differently by different individuals and market segments, depending on income levels and other variables. However, several important aspects of the dollar cost of offerings are not always considered. One of these concerns the source of funds for a particular purchase. We suspect that money received as a tax rebate, gift, interest, or gambling winnings has a different value to many consumers than money earned through work. Consequently, the dollar price of a particular item may be perceived differently by the same individual, depending on what sources of funds are used to pay for it.

 Similarly, the actual price of a credit card purchase that will be financed at 16 percent for an extended period is much different from the price if cash is used. To consumers who are accustomed to carrying large credit card balances, this difference may be irrelevant; to others, the difference may forestall or eliminate a purchase. In addition, the type of work consumers do may affect how valuable a particular amount of money is to them, as well as affect their willingness to spend that money on particular products and services. Shipping costs and return shipping costs for Internet purchases increase dollar costs for consumers.

 A number of methods can reduce the dollar amount spent for a particular item, although they often involve increasing other costs. For example, time, cognitive activity, and behavior effort are required to clip and use coupons, mail in for rebates, or download coupons from Internet sites. Shopping at different stores seeking the lowest price not only involves time, cognitive activity, and behavior effort but also increases other dollar costs, such as transportation or parking. Consumer Insight 18.1 discusses consumer price sensitivity to changes in money costs.

 Consumer Insight 18.1

Consumer Price Sensitivity and Money Cost

Generally, as the money cost of a product increases, its sales will decrease because fewer and fewer consumers feel the product is a good value. The price sensitivity of consumers determines how many units will be sold at different price levels. If consumers in the target market are very price sensitive, sales will decrease significantly when prices increase. If consumers are not very price sensitive, sales will not decrease significantly if the prices are increased.

 The target market for a product is generally viewed to be price insensitive (referred to as inelastic) when its price elasticity is greater than –1—that is, when a 1 percent decrease in price results in less than a 1 percent increase in quantity sold. The target market for a product is price sensitive (referred to as elastic) when the price elasticity is less than –1—that is, when a 1 percent decrease in price produces more than a 1 percent increase in quantity sold. The price elasticity for a product can be estimated by conducting an experiment or by using statistical techniques to analyze how sales have changed in the past when prices changed.

 Various factors affect the price sensitivity for a product. First, the more substitutes a product or service has, the more likely it is to be price elastic (sensitive). For example, there are many alternatives for McDonald’s sandwich meals, and thus, fast food prices are typically price elastic, but branded luxury goods have almost no substitutes and are price inelastic (insensitive). Second, products and services that are necessities are price inelastic. Thus, medical care is price inelastic, whereas airline tickets for a vacation are price elastic. Third, products that are expensive relative to a consumer’s income are price elastic. Thus, cars are price elastic, and books and movie tickets tend to be price inelastic. The estimated elasticities for some commonly purchased items are shown below.

 Based on these estimates, a 1 percent decrease in the price of clothing would result in only a 0.90 percent increase in the quantity sold in the short run but a 2.90 percent increase in the long run. So if you must have that new sweater today, you are much less responsive to a low price than if you can wait for the sweater to be on sale three months from now. In contrast, Americans aren’t going to change their gasoline purchases much in the short or long run, regardless of slight price decreases or increases. However, these elasticity estimates are based on relatively small changes in prices and can be very different for large price changes.

18 ch

TIME

The time necessary to learn about a product or service and to travel to purchase it, as well as the time spent in a store, can be important costs to the consumer. Most consumers are well aware that convenience food stores usually charge higher prices than supermarkets. Many convenience food stores are very profitable, for most consumers purchase from them at least occasionally. Clearly these consumers often make a tradeoff of paying more money to save time, particularly if only a few items are to be purchased. Time savings may result because the convenience outlets are located closer to home and thus require less travel time or because less time is required in the store to locate the product and wait in line to pay for it. Given the high cost of operating an automobile, it may even be cheaper in dollar terms to shop at stores that are closer to home, even if they have higher prices! Thus, bargain hunters who travel all over town to save 25 cents here and 50 cents there may be fooling themselves if they think they are saving money. Internet purchasing may save time for some consumers, but they must wait at least a few days for delivery of most products.

 However, we should not treat time only as a cost of purchasing. In some situations, the process of seeking product information and purchasing products is a very enjoyable experience—rather than a cost—for consumers. For instance, many consumers enjoy Christmas shopping and spend hours at it. Some consumers enjoy window shopping and purchasing on occasion, particularly if the opportunity cost of their time is low. In areas that offer shopping on Sunday, some consumers prefer going to the mall rather than sitting at home watching football games. Similarly, some consumers enjoy spending hours looking through catalogs or surfing the Web for their favorite merchandise. Thus, although in an absolute sense consumers must spend time to shop and make purchases, in some cases this may be perceived as a benefit rather than a cost.

COGNITIVE ACTIVITY

One frequently overlooked cost of making purchases is the cognitive activity involved. Thinking and deciding what to buy can be very hard work. For example, when all of the styles, sizes, colors, and component options are considered, one Japanese manufacturer offers more than 11 million variations of custom-made bicycles. Consumers would never evaluate all 11 million options, but consider the cognitive activity required to evaluate even a small fraction of them. Clearly, it would not only take a lot of time but also involve very taxing cognitive work. If even a few comparisons are made, some cognitive effort must be expended; excessive cognitive effort can cause negative affect.

 In addition to all the cognitive work involved in comparing purchase alternatives, the process can be stressful. Some consumers find it very difficult and dislike making purchase (or other types of) decisions. To some, finding a parking space, shopping in crowded malls and stores, waiting in long checkout lines, and viewing anxietyproducing ads can be very unpleasant emotional experiences. Consumers who lack the skills to surf the Net efficiently can find shopping online stressful. Also, the perceived risks of shopping online, such as sending credit card numbers or uncertainty about product quality, can be distressing. Thus, the cognitive activity involved in purchasing can be a very important cost.

 The cost involved in decision making is often the easiest one for consumers to reduce or eliminate. Simple decision rules or heuristics can reduce this cost considerably. By repeatedly purchasing the same brand, for example, consumers can practically eliminate any decision making within a product class. Other heuristics might entail purchasing the most expensive brand, the brand on sale or display, the brand Mom or Dad used to buy, the brand a knowledgeable friend recommends, or the brand a selected dealer carries.

 On the other hand, in some situations consumers actively seek some form of cognitive involvement. Fishing enthusiasts frequently enjoy comparing the attributes of various types of equipment, judging their relative merits, and assessing the ability of different equipment to catch fish. We suspect that although consumers may enjoy periods in which they are not challenged to use much cognitive energy or ability, they may also seek purchasing problems to solve as a form of entertainment.

 Behavior Effort

Anyone who has spent several hours walking around in malls can attest to the fact that purchasing involves behavior effort. When large shopping malls were first developed, one of the problems they faced was that consumers had long walks from the parking lot and considerable distance to cover within the mall itself. Many consumers were not physically comfortable with this much effort, and some avoided malls or shopped in only a small number of the stores available. Primarily to overcome this problem, benches and chairs were placed in malls to give consumers places to rest while shopping. Shopping online is a welcome alternative for disabled people and others who have trouble walking long distances in stores and malls. However, returning unwanted or damaged merchandise ordered online is considered wasted time by most consumers.

 Like time and cognitive activity, behavior effort can be a benefit rather than a cost. For example, walking in malls and stores is good exercise and is sometimes done as a source of relaxation. Some malls provide early-morning mall-walking programs for senior citizens. These programs aim to create a positive image for malls and bring in potential buyers.

 Perhaps the most interesting aspect of behavior effort is the willingness of consumers to take on some marketing costs to reduce the dollar amount they spend and to make trade-offs among various types of costs. In some cases, consumers will perform part of the production process to get a lower dollar price. For example, consumers may forgo the cost of product assembly for bicycles and toys and do it themselves to save money.

 There are also cases in which consumers will take on at least part of the cost of distribution to lower the dollar price. At one time, for example, milk was commonly delivered to the home; now most consumers purchase it at stores. Consumers with access to a pickup truck frequently bring home their own furniture and appliances rather than pay a store for delivery. Catalog purchases require the consumer to pay the cost of shipping directly, yet may be less expensive than store purchases. If they are not, the consumer at least saves shopping time and effort to have the product delivered to the home. As we noted earlier in the text, consumers will also perform promotion and marketing research for firms to receive lower prices or other merchandise “free.”

 A final trade-off of interest in terms of pricing concerns the degree to which consumers participate in purchase/ownership. Consumers have several options with regard to purchase: (1) They can buy the product and enjoy its benefits as well as incur other costs, such as inventory and maintenance; (2) they can rent or lease the product and enjoy its benefits but forgo ownership and often reduce some of the other costs, such as maintenance; (3) they can hire someone else to perform whatever service the product is designed to perform and forgo ownership and other postpurchase costs; or (4) they can purchase the product and hire someone else to use and maintain it for them. For many durable goods, such as automobiles, appliances, power tools, furniture, and lawn mowers, at least several of these options are available. Clearly, as we stated at the beginning of the chapter, price is a lot more than just dollars and cents!

PRICE AFFECT

We have discussed four aspects of price from the consumer’s point of view. We have suggested that consumers can sometimes reduce one or more of these costs, but this usually requires an increase in at least one of the other costs. Purchases can be viewed in terms of which of the elements is considered a cost or a benefit and which is considered most critical for particular purchases. However, regardless of what cost tradeoffs are made, it seems that whatever is being purchased must be perceived to be of greater value to the consumer than merely the sum of the costs. In other words, the consumer perceives that the purchase offers benefits greater than the costs and is willing to exchange to receive these benefits.

 Although this view of price is useful, we want to restate that consumers seldom (if ever) thoroughly calculate each of these costs and benefits in making brand-level decisions. Rather, for many types and brands of consumer packaged goods, the amounts of money, time, cognitive activity, and behavior effort required for a purchase are very similar. For these goods, choices among brands may be made on the basis of particular benefits or imagery, although price deals are often important.

 For some purchases, consumers may consider all the costs and trade-offs. But the major importance of our view of price is not the degree to which consumers actively analyze and compare each cost of a particular exchange. Instead, this view is important because it has direct implications for the design of marketing strategy, as discussed later in the chapter.

 Price Affect and Cognition

As we noted, little sensory experience typically is connected with the price variable. Yet information about prices is often attended to and comprehended, and the resulting meanings may influence consumer behavior. For some purchases, consumers may make a variety of price comparisons among brands and evaluate trade-offs among the various types of consumer costs and values.

 Several attempts have been made to summarize the research on the effects of price on consumer affect, cognition, and behavior, but these reviews have found few generalizations. For example, it has long been believed that consumers perceive a strong relationship between price and the quality of products and services. Experiments typically find this relationship when consumers are given no other information about the product except dollar price. However, when consumers are given additional information about products (which is more consistent with marketplace situations), the price–quality relationship diminishes.

 In general, all of these reviews conclude that research on the behavioral effects of pricing has not been based on sound theory and that most of the studies are seriously flawed methodologically. Thus, it should not be surprising that there is little consensus on basic issues regarding how price influences consumer choice processes and behavior.

PRICE PERCEPTIONS

Price perceptions concern how price information is comprehended by consumers and made meaningful to them. One approach to understanding price perceptions is information processing, which has been advocated by Jacob Jacoby and Jerry Olson. Exhibit 18.3 outlines an adaptation of this approach.

 This model illustrates an approach to describing price effects for a high-involvement product or purchase situation. Basically it suggests that price information is received through the senses of sight and hearing. The information is then comprehended, which means it is interpreted and made meaningful (i.e., consumers understand the meanings of price symbols through previous learning and experience).

 In the cognitive processing of price information, consumers may make comparisons between the stated price and a price or price range they have in mind for the product. The price they have in mind for making these comparisons is called the internal reference price. The internal reference price may be what consumers think is a fair price, what the price has been historically, or what consumers think is a low or a high market price. Basically an internal reference price serves as a guide for evaluating whether the stated price is acceptable to the consumer. For example, a consumer may think 50 cents is about the right price to pay for a candy bar. When a vending machine offers candy bars for 75 cents, the internal reference price may inhibit purchase because the asking price is too high.

 The stated price for a particular brand may be considered a product attribute. This knowledge may then be compared with the dollar prices of other brands in a product class, other attributes of the brand and other brands, and other consumer costs. An attitude is formed toward the various brand alternatives that may lead to purchase behavior.

 For a low-involvement product or purchase situation, dollar price may have little or no impact on Consumer Affect and Cognition or behavior. For many products, consumers may have an implicit price range, and as long as prices fall within it, price is not even evaluated as a purchase criterion. Similarly, some products are simply purchased without ever inquiring as to the price but simply paying whatever is asked for at the point of purchase. Impulse items located in the checkout area of supermarkets and drugstores are frequently purchased this way, as are other products for which the consumer is highly brand loyal. In the latter cases, consumers may make purchases on the single attribute of brand name without comparing dollar price, other consumer costs, or other factors.

 In other cases, price information may not be carefully analyzed because consumers have a particular price image for the store they are shopping in. Discount stores such as Walmart or Shopko may be generally considered low-priced outlets, and consumers may forgo comparing prices at these outlets with those at other stores.

 Consumers often do not carefully store detailed price information in memory, even for products they purchase. For example, in a study of grocery shoppers, the researchers concluded:

 What is surprising is just how imperfect [price] information attention and retention are at the very point of purchase. The fact is that less than half of the shoppers could recall the price of the item they had just placed in their shopping basket, and less than half were aware they had selected an item that was selling at a reduced price. Only a small minority of those who bought a special knew both its price and the amount of the price reduction.

 There are good reasons many consumers do not methodically store in memory the prices of individual products. Consumers probably do not want to exert the considerable effort necessary to obtain, store, and revise prices for the many products they buy. For many purchases, other than using coupons or haggling, consumers must pay the stated price or forgo purchase. Thus, if they choose to purchase, the price is uncontrollable by them and it likely makes little sense to carefully store price information when it has little impact on saving money. In sum, the cognitive activity costs, behavior effort costs, and time costs involved in storing price information and shopping carefully are often not worth expending to save a few dollars.

 Price Behavior

Depending on the consumer, the product, and its availability in various stores and other channels, and other elements of the situation, price can affect a variety of consumer behaviors. Two types of behaviors are particularly relevant to the price variable: funds access and transactions.

Exhibit 18.3

FUNDS ACCESS

One source of embarrassment for most of us as consumers is to arrive at the point in the purchase process where we have to produce funds for an exchange and realize we do not have sufficient funds. Not having enough money at the grocery checkout and having to replace several items can be embarrassing, particularly when the total amount of money needed is quite small. Similarly, it is embarrassing to bounce a check, to have a credit card purchase refused because we have exceeded our limit, or to be refused a purchase because of a poor credit rating. For these reasons, most of us are likely to plan for funds access to ensure sufficient funds are available when we go shopping.

 As noted previously, consumers have several ways to access funds. First, many consumers carry a certain amount of cash to pay for small purchases. This cash supply may be replenished as needed for day-to-day activities. Second, many consumers also carry checkbooks (or at least a few blank checks) in case a need arises for a larger amount of money. Third, millions of Americans carry credit cards to handle purchases. Although the interest rates on credit cards are often high, this method of accessing funds is very popular.

 Credit card purchases and payments not only are convenient for the consumer but may also make the purchase seem less expensive. This is because consumers do not see any cash flowing from their pockets or a reduction in their checkbook balances; they merely need to sign their names and not even think about payment until the end of the month. In one sense, if no balance is carried over on the credit card, the purchase is “free” for the time between the exchange and the payment. We suspect that although many consumers keep tabs on their checkbook balances, they may be less concerned about their credit card balances throughout the month, unless they are close to their credit limits.

 Credit cards also facilitate purchasing because little effort is required to access funds. Even going to a bank to cash a check before shopping requires more effort than using a credit card. Thus, overall, the use of credit cards may reduce consumers’ time, cognitive activity, and behavior effort costs.

PRICE ENVIRONMENT

The exchange of funds for products and services is typically a relatively simple transaction. It usually involves handing over cash, filling out a check, signing a credit slip, sending a credit card number to a Web site, or signing a credit contract and following up by making regular payments.

 However, as we have emphasized throughout this chapter, consumers exchange much more than simply money for goods and services. They also exchange their time, cognitive activity, and behavior effort—not only to earn money but also to shop and make purchases. Thus, analysis of these elements, and of the value consumers receive in purchase and consumption, may provide better insights into the effects of price on consumer behavior. Consumer Insight 18.2 discusses the elements of price involved in mail-in rebates.

 Price Environment

As we stated at the beginning of the chapter, price is perhaps the most intangible element of the marketing mix. From an environmental perspective, this means the price variable typically offers very little for the consumer to experience at the sensory level, although it may generate considerable cognitive activity and behavior effort. In the environment, price is usually a sign, a tag, a few symbols on a package, or a few words spoken on TV, on radio, or by a salesperson in a store or on the phone. The price variable also includes purchase contracts and credit term information.

 The price variable may also include an external reference price. An external reference price is an explicit comparison of the stated price with another price in advertising, catalog listings, price guides, shopping tags and store displays, or sales presentation. For example, the stated price may be compared with the seller’s former price (“$11.95, marked down from $15.00”), with the manufacturer’s suggested retail price (“Manufacturer’s suggested retail price—$50, on sale today for $39.95”), or with prices at competing stores (“$54.95, lowest price in town”). External reference prices are used to enhance the attractiveness of the stated price.

 How price information is communicated also has an effect. For example, the advent of scanner checkout systems has reduced price information in the environment for many grocery products because prices are no longer stamped on each package or can. A study by Valerie Zeithaml found that having each item marked increased consumers’ certainty of price recall and decreased errors in both exact price and unit price recall. 10 The study also found some differences in the impacts of shelf price tags, supporting the idea that not only the price itself but also the method by which price information is communicated influences consumer affect, cognition, and behavior.

 Pricing Strategy

Pricing strategy is of concern in three general situations: (1) when a price is being set for a new product, (2) when a long-term change is being considered for an established product, and (3) when a short-term price change is being considered. Marketers may change prices for a variety of reasons, such as an increase in costs, a change in the price of competitive products, or a change in distribution channels.

 Many models have been offered to guide marketers in designing pricing strategies. Most of these models contain very similar recommendations and differ primarily in terms of how detailed the assumptions are, how many steps the pricing process is divided into, and in what sequence pricing tasks are recommended. For our purposes, we have developed a six-stage model, shown in Exhibit 18.4 . Our model differs from traditional approaches primarily in that it places greater emphasis on consumer analysis and gives greater attention to the four types of consumer costs in developing pricing and marketing strategies.

 The six stages in our strategic approach to pricing are discussed next. Although consumer analysis is not the major focus in all the steps, our discussion is intended to clarify the role of consumer analysis in pricing and to offer a useful overview of the pricing process.

 Consumer Insight 18.2

The Price of Mail-in Rebates

While consumers often dislike the time, cognitive activity, and behavior effort required to redeem mail-in rebates, they frequently buy products based, in part, on the expected savings. However, fully 40 percent of all rebates never get redeemed. Some consumers are just too lazy, forgetful, or busy to apply for the rebates; others think that the $.50, $50, or even $200 isn’t worth the hassle of collecting. However, many consumers, as well as state and federal agencies, suspect that companies design rebate rules to keep redemption rates down. They say companies count on complex rules, filing periods of as little as a week, repeated requests for copies or receipts, and long delays in sending out checks to discourage consumers from even attempting to retrieve their money. Checks are also sent in envelopes with the name of another company on them so that consumers may just throw them away as junk mail and never cash the check. Purchases by consumers who never file for a rebate are called “breakage” while mailed rebate checks that are never cashed are called “slippage.”

 Of course, retailers and suppliers benefit greatly from sales that end up being full-priced because they did not have to pay the rebate. This amounts to over $2 billion each year.The consumer backlash against mail-in rebates has led a number of companies to drop them. Best Buy has begun to phase them out and Staples has switched to an online system called Easy Rebates that customers can use to file for rebates and track their progress.

 If consumers believe that the money from a mail-in rebate is worth the time, cognitive activity, and behavior effort, then here are some tips for getting it:

Don’t toss that box. With most rebates, you must clip and send in the UPC codes printed on the packaging.
Keep those receipts. Nearly all rebates make you mail in the receipts—sometimes the originals—as proof of purchase.
Make copies of everything. Chances are a snafu will occur and you may have to resubmit your application.
Don’t delay. After the purchase you may have as little as a week to send in the paperwork.
Be sure to follow up. Complaining may be the only way to shake loose your rebate check.
Sort the mail carefully. Checks can look like junk mail, so be careful not to throw them out.

Exhibit 18.4

CONSUMER–PRODUCT RELATIONSHIPS

Pricing strategy for a new product generally starts with at least one given: The firm has a product concept or several variations of a product concept in mind. When a price change for an existing product is being considered, much more information is typically available, including sales and cost data.

 Whether the pricing strategy is being developed for a new or existing product, a useful first stage in the process is to analyze the Consumer–Product Relationship. Answers must be found for questions such as: How does the product benefit consumers? What does it mean to them? In what situations do they use it? Does it have any special psychological or social significance to them? Of course, the answers to these questions depend on which current or potential target markets are under consideration.

 A key question is whether the product itself has a clear competitive advantage that consumers would be willing to pay for or whether a competitive advantage must be created on the basis of other marketing mix variables. This question has important implications for determining which of the four areas of consumer costs (time, money, cognitive activity, or behavior effort) can be appealed to most effectively.

 Suppose a firm is deciding whether to sell its products in traditional stores or on the Internet. After delineating its target market, one thing the firm should do is evaluate consumer costs for shopping and purchasing from these two alternatives. Surely, for most convenience goods, selling in-store is the likely alternative. However, for some shopping and specialty goods, e-tailing to consumers makes sense.

 Exhibit 18.5 compares consumer costs for in-store versus online purchases. In terms of money, it is likely a company would sell its products at a lower price on the Web. Most companies have tried to attract consumers to make Internet purchases by offering lower prices. Web purchases also save consumers travel costs, such as the costs of gasoline to drive to stores and to park their cars. However, consumers usually pay shipping charges for products bought on the Internet. Even so, money costs are likely to be lower for most products when bought online. The firm would have to decide whether it should compete on the basis of money costs or on other costs or benefits to consumers.

 There is no question that skillful consumers can save time shopping on the Internet. The ability to shop at a number of sites while sitting at home or in one’s office is a convenience compared to traveling all over town looking at a variety of stores and merchandise. However, many consumers prefer to get merchandise immediately rather than wait a few days or weeks for delivery. The firm should determine whether consumers in their target market want the product immediately or don’t mind waiting for delivery.

 Effective online shopping likely takes more skill than simply going to a store or two and picking out a product. The consumer needs skills to navigate Web sites efficiently and must be willing to put up with Web sites that are not user-friendly. In addition, decision-making effort is likely greater online, since many more sites and alternative products are readily available for consideration. This, coupled with risks associated with unknown Web companies, credit card security, and uncertainty about product quality prior to purchase, may increase the stress of online purchasing. In addition, some commercial Web sites cannot handle a large number of orders during peak demand periods, such as the Christmas season, increasing stress and disappointment if the product is not delivered in a timely fashion. The firm should determine the computer sophistication of its target market and consumers’ willingness to shop for that type of product online before selecting this channel.

 As noted previously, the energy spent traveling and shopping in stores and malls can be a significant barrier for some consumers. This makes online shopping more convenient for many consumers. However, repackaging and returning merchandise that does not meet the consumer’s needs usually requires greater effort than simply returning a product to a store. For products that vary greatly in terms of style and quality, this is an important consideration.

 This discussion suggests several generalizations about analyzing consumer–product relationships in terms of consumer costs. First, one important outcome of analyzing consumer–product relationships is an estimate of how sensitive the target market is to money costs. In economics, one measure of this sensitivity is price elasticity, the relative change in demand for a product for a given change in dollar price as discussed in Consumer Insight 18.1. If consumers are highly price sensitive, this suggests that competing on price may be the only alternative. Amazon.com has become one of the bestknown e-marketers primarily by competing on low price, although some analysts argue that this company loses money on some products it sells. The strategy of trying to build an online market primarily by focusing consumers only on low prices led many online marketers to bankruptcy. Competitive prices, coupled with security, convenience, and extensive product lines is often a winning online strategy.

 Second, competing on marketing mix variables other than money costs is often a more defensible and more profitable strategy. The ability to save consumers time, cognitive activity, or behavioral effort can give a company a competitive advantage and be more profitable than competing on money costs alone. Offering superior product quality through research and development, creating superior brand equity through advertising, or offering superior customer service or outstanding product assortments often is a better strategy than competing on money costs alone.

 Finally, there is the question of what value consumers receive from purchasing a product in-store versus online. In-store purchases can provide value in that they lower purchasing risks and can be enjoyable experiences. Online purchases can provide value by saving time and effort and offering lower money costs and larger product assortments.

Exhibit 18.5

ENVIRONMENTAL SITUATION

There is no question that a firm must consider elements of the environment— economic trends, political views, social changes, and legal constraints—when developing pricing strategies. These elements should be considered early in the process of formulating any part of marketing strategy and should be monitored continually. By the time a firm is making pricing decisions, many of these issues have already been considered. Although this may also be true for competitive analysis, consideration of competition at this point is critical in developing pricing strategies.

 In setting or changing prices, the firm must address its competition and how that competition will react to the product’s price. Initially consideration should be given to such factors as

• Number of competitors.
• Market share of competitors.
• Location of competitors.
• Conditions of entry into the industry.
•Degree of vertical integration of competitors.
• Financial strength of competitors.
• Number of products and brands sold by each competitor.
• Cost structure of competitors.
• Historical reaction of competitors to price changes.

 Analysis of these factors helps determine whether the dollar price should be at, below, or above competitors’ prices. However, this analysis should also consider other consumer costs relative to competitive offerings. Consumers often pay higher dollar prices to save time and effort.

ROLE OF PRICE

This step involves determining whether the dollar price is to be a key aspect of positioning the product or whether it is to play a different role. If a firm is attempting to position a brand as a bargain product, setting a lower dollar price is clearly an important part of this strategy. Barbasol shaving cream positions itself as just as good as but half the price of other brands, for example. Similarly, if a firm is attempting to position a brand as a prestige, top-of-the-line item, a higher dollar price is a common cue to indicate this position. For example, BMW has long used this approach for its automobiles. The success of these types of strategies also depends on analyzing the tradeoffs with other elements of consumer costs.

 In many situations, dollar price may not play a particularly important positioning role other than in terms of pricing competitively. If consumers enjoy greater convenience in purchasing (e.g., free delivery), or if the product has a clear competitive advantage, the price may be set at or above those of the competition but not highlighted in the positioning strategy. In other cases, when the price of a product is higher than that of the competition but there is no clear competitive advantage, the price may not be explicitly used in positioning. For example, premium-priced beers do not highlight price as part of the appeal.

RELEVANT PRODUCTION

The costs of producing and marketing a product provide a useful benchmark for making pricing decisions. The variable costs of production and marketing usually determine the lowest dollar price a firm must charge to make an offering in the market. However, there are some exceptions to this rule. These exceptions typically involve interrelationships among products. For example, a firm may sell an item below cost (i.e., a loss leader) to build traffic and increase sales of other items.

PRICING OBJECTIVES

Pricing objectives should be derived from overall marketing objectives, which in turn should be derived from Corporate Objectives. In practice, the most common objective is to achieve a target return on investment. This objective has the advantage of being quantifiable, and also offers a useful basis for making not only pricing decisions but also decisions on whether to enter or remain in specific markets. For example, if a firm demands a 20 percent return on investment, and the best estimates of sales at various prices indicate a product would have to be priced too high to generate demand, the decision may be to forgo market entry. However, marketers should be aware of the sensitivity of profits to small differences in the prices they receive for their products and services, as discussed in Consumer Insight 18.3.

 Consumer Insight 18.3

Effects on Profitability of Small Changes in Price

Small changes in the price marketers receive can lead to large differences in net income. For example, at Coca-Cola a 1 percent increase in the price received for its products would result in a net income boost of 6.4 percent; at Fuji Photo, 16.7 percent; at Nestlé, 17.5 percent; at Ford, 26 percent; and at Philips, 28.7 percent. In some companies, a 1 percent increase in the price received would be the difference between a profit and a significant loss. Given the cost structure of large corporations, a 1 percent boost in realized price yields an average net income gain of 12 percent. In short, when setting pricing objectives and developing pricing strategies, it’s worth the effort to do pricing research to see what prices consumers are willing to pay and still believe they are receiving good value.