Companies usually do not set a single price but rather develop a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels, delivery frequency, guarantees, service contracts, and other factors. As a result of discounts, allowances, and promotional support, a company rarely realizes the same profit from each unit of a product that it sells. Here we will examine several price-adaptation strategies: geographical pricing, price discounts and allowances, promotional pricing, and differentiated pricing.
1. GEOGRAPHICAL PRICING (CASH, COUNTERTRADE, BARTER)
In geographical pricing, the company decides how to price its products to different customers in different locations and countries. Should the company charge higher prices to distant customers to cover higher shipping costs or a lower price to win additional business? How should it account for exchange rates and the strength of different currencies?
Another question is how to get paid. This issue is critical when buyers lack sufficient hard currency to pay for their purchases. Many want to offer other items in payment, a practice known as countertrade, and U.S. companies are often forced to accept if they want the business. Countertrade may account for 15 percent to 20 percent of world trade and takes several forms:68
- Barter. The buyer and seller directly exchange goods, with no money and no third party involved.
- Compensation deal. The seller receives some percentage of the payment in cash and the rest in products. A British aircraft manufacturer sold planes to Brazil for 70 percent cash and the rest in coffee.
- Buyback arrangement. The seller sells a plant, equipment, or technology to a company in another country and agrees to accept as partial payment products manufactured with the supplied equipment. A U.S. chemical company built a plant for an Indian company and accepted partial payment in cash and the remainder in chemicals manufactured at the plant.
- Offset. The seller receives full payment in cash for a sale overseas but agrees to spend a substantial amount of the money in that country within a stated time period. In the Gorbachev era, PepsiCo sold its cola syrup to the government of the Soviet Union for rubles and agreed to buy Russian vodka at a certain rate for sale in the United States.69
2. PRICE DISCOUNTS AND ALLOWANCES
Most companies will adjust their list price and give discounts and allowances for early payment, volume purchases, and off-season buying (see Table 16.4).70 Companies must do this carefully or find their profits much lower than planned.71
Discount pricing has become the modus operandi of a surprising number of companies offering both products and services. Salespeople in particular are quick to give discounts to close a sale. But word can get around fast that the company’s list price is “soft,” and discounting becomes the norm, undermining the perceived value of the offerings. Some product categories self-destruct by always being on sale.
Some companies with overcapacity are tempted to give discounts or even begin to supply a retailer with a store-brand version of their product at a deep discount. Because the store brand is priced lower, however, it may start making inroads on the manufacturer’s brand. Manufacturers should consider the implications of supplying retailers at a discount because they may end up losing long-run profits in an effort to meet short-run volume goals.
Only people with higher incomes and higher product involvement willingly pay more for features, customer service, quality, added convenience, and the brand name. So it can be a mistake for a strong, distinctive brand to plunge into price discounting as a response to low-price attacks. At the same time, discounting can be a useful tool if the customer will give concessions in return, such as signing a longer contract, ordering electronically, or buying larger quantities.
Sales management needs to monitor the proportion of customers receiving discounts, the average discount, and any tendency for salespeople to over-rely on discounting. Upper management should conduct a net price analysis to arrive at the “real price” of the offering. The real price is affected not only by discounts but by other expenses that reduce the realized price (see “Promotional Pricing” below). Suppose the company’s list price is $3,000. The average discount is $300. The company’s promotional spending averages $450 (15 percent of the list price). Retailers are given co-op advertising money of $150 to back the product. The company’s net price is $2,100, not $3,000.
3. PROMOTIONAL PRICING
Companies can use several pricing techniques to stimulate early purchase:
- Loss-leader pricing. Supermarkets and department stores often drop the price on well-known brands to stimulate additional store traffic. This pays if the revenue on the additional sales compensates for the lower margins on the loss-leader items. Manufacturers of loss-leader brands typically object because this practice can dilute the brand image and bring complaints from retailers who charge the list price. Manufacturers have tried to keep intermediaries from using loss-leader pricing by lobbying for retail-price-maintenance laws, but these laws have been revoked.
- Special event pricing. Sellers will establish special prices in certain seasons to draw in more customers. Every August, there are back-to-school sales.
- Special customer pricing. Sellers will offer special prices exclusively to certain customers. Members of Road Runner Sports’ Run America Club get “exclusive” online offers with price discounts twice those given to regular customers.72
- Cash rebates. Auto companies and other consumer-goods companies offer cash rebates to encourage purchase of the manufacturers’ products within a specified time period. Rebates can help clear inventories without cutting the stated list price.
- Low-interest financing. Instead of cutting its price, the company can offer low-interest financing. Automakers have used no-interest financing to try to attract more customers.
- Longer payment terms. Sellers, especially mortgage banks and auto companies, stretch loans over longer periods and thus lower the monthly payments. Consumers often worry less about the cost (the interest rate) of a loan and more about whether they can afford the monthly payment.
- Warranties and service contracts. Companies can promote sales by adding a free or low-cost warranty or service contract.
- Psychological discounting. This strategy sets an artificially high price and then offers the product at substantial savings; for example, “Was $359, now $299.” Discounts from normal prices are a legitimate form of promotional pricing; the Federal Trade Commission and Better Business Bureau fight illegal discount tactics.
Promotional-pricing strategies are often a zero-sum game. If they work, competitors copy them and they lose their effectiveness. If they don’t work, they waste money that could have been put into other marketing tools, such as building up product quality and service or strengthening product image through advertising.
4. DIFFERENTIATED PRICING
Companies often adjust their basic price to accommodate differences among customers, products, locations, and so on. Lands’ End creates men’s shirts in many different styles, weights, and levels of quality. In March 2014, a men’s white button-down shirt could cost as little as $19.99 or as much as $70.00.73
Price discrimination occurs when a company sells a product or service at two or more prices that do not reflect a proportional difference in costs. In first-degree price discrimination, the seller charges a separate price to each customer depending on the intensity of his or her demand.
In second-degree price discrimination, the seller charges less to buyers of larger volumes. With certain services such as cell phone service, however, tiered pricing results in consumers actually paying more with higher levels of usage. With the iPhone, 3 percent of users accounted for 40 percent of the traffic on AT&T’s network, resulting in costly network upgrades to AT&T and causing the firm to set higher prices for those users.74
In third-degree price discrimination, the seller charges different amounts to different classes of buyers, as in the following cases:75
- Customer-segment pricing. Different customer groups pay different prices for the same product or service. For example, museums often charge a lower admission fee to students and senior citizens.
- Product-form pricing. Different versions of the product are priced differently, but not in proportion to their costs. Evian prices a 2-liter bottle of its mineral water as low as $1 but 5 ounces of the same water in a moisturizer spray for as much as $12.
- Image pricing. Some companies price the same product at two different levels based on image differences. A perfume manufacturer can put a scent in one bottle, give it a name and image, and price it at $10 an ounce. The same scent in another bottle with a different name and image can sell for $30 an ounce.
- Channel pricing. Coca-Cola carries a different price depending on whether the consumer purchases it from a fine restaurant, a fast-food restaurant, or a vending machine.
- Location pricing. The same product is priced differently at different locations even though the cost of offering it at each location is the same. A theater varies its seat prices according to audience preferences for different locations.
- Time pricing. Prices vary by season, day, or hour. Restaurants charge less to “early bird” customers, and some hotels charge less on weekends. Retail prices for roses increase by as much as 200 percent in the lead-up to Valentine’s Day.76
The airline and hospitality industries use yield management systems and yield pricing, by which they offer discounted but limited early purchases, higher-priced late purchases, and the lowest rates on unsold inventory just before it expires. Airlines charge different fares to passengers on the same flight, depending on the seating class; the time of day (morning or night coach); the day of the week (workday or weekend); the season; the person’s employer, past business, or status (youth, military, senior citizen); and so on. That’s why on a flight from New York City to Miami you might pay $200 and sit across from someone who paid $1,290.
The phenomenon of offering different pricing schedules to different consumers and dynamically adjusting prices is exploding. Merchants are adjusting process based on inventory levels, item velocity or how fast it sells, competitor’s pricing, and advertising. Even sports teams are adjusting ticket prices to reflect the popularity of the competitor and the timing of the game.77
Many companies are using software to make real-time controlled tests of actual consumer response to different pricing schedules. Online merchants selling their products on Amazon.com are changing their prices on an hourly or even minute-by-minute basis, in part so they can secure the top spot on search results.78
Constant price variation can be tricky, however, where consumer relationships are concerned. Research shows it’s most effective when there’s no bond between the buyer and the seller. One way to make it work is to offer customers a unique bundle of products and services to meet their needs precisely, making it harder to make price comparisons. The tactic most companies favor is to use variable prices as a reward rather than a penalty. Shipping company APL rewards customers who can better predict how much cargo space they’ll need with cheaper rates for booking early.
Customers are getting savvier about how to avoid overpaying, changing their buying behavior to accommodate the new realities of dynamic pricing. But most are probably not even aware of the degree to which they are the targets of discriminatory pricing. Retailers like Staples, Office Depot, and Home Depot vary their online and in-store prices on a host of factors related to costs of doing business and consumer sensitivity to prices. Some firms use computer IP addresses to deduce peoples zip codes and use their proximity to a competitor’s store to adjust their prices.
When online travel agency Orbitz found that people using Apple Mac computers spent as much as 30 percent more a night on hotels, it began to show them different, and sometimes costlier, travel options than Windows users saw. Orbitz also considers a user’s location and history on the site as a well as a hotels overall popularity and promotions.79
Although some forms of price discrimination are illegal (such as offering different prices to different customers within the same trade group), the practice is legal if the seller can prove its costs are different when selling different volumes or different qualities of the same product to different retailers. Predatory pricing—selling below cost with the intention of destroying competition—is unlawful, though.
For price discrimination to work, certain conditions must exist. First, the market must be segmentable and the segments must show different intensities of demand. Second, members in the lower-price segment must not be able to resell the product to the higher-price segment. Third, competitors must not be able to undersell the firm in the higher-price segment. Fourth, the cost of segmenting and policing the market must not exceed the extra revenue derived from price discrimination. Fifth, the practice must not breed customer resentment and ill will. Sixth, of course, the particular form of price discrimination must not be illegal.80
Source: Kotler Philip T., Keller Kevin Lane (2015), Marketing Management, Pearson; 15th Edition.