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CHAPTER 11

MANAGING PrIcING AND SALES PrOMOTIONS 269 upgraded bottle and claims of being “matured in a precious wooden cask like a Scotch whiskey” allow

it to command a $44 price tag.13 Pricing Cues. Pricing cues are also important in the psychology of pricing. Many sellers believe

prices should end in an odd number. Customers perceive an item priced at $299 to be in the $200 rather

than the $300 range; they tend to process prices “left to right” rather than by rounding. Price encoding

in this fashion is important if there is a mental price break at the higher, rounded price. Another explanation for the popularity of “9” endings is that they suggest a discount or bargain,

so if a company wants a high-price image, it should probably avoid the odd-ending tactic. One study

showed that demand actually increased when the price of a dress rose from $34 to $39 but was

unchanged when it rose from $34 to $44.14 Prices that end with 0 and 5 are also popular and are thought to be easier for consumers to process

and retrieve from memory. “Sale” signs next to prices spur demand, but only if not overused. Thus total

category sales are highest when some—but not all—items in a category have sale signs; past a certain

point, sale signs may cause total category sales to fall.15 Pricing cues such as sale signs and prices that end in 9 are more influential when consumers’ price

knowledge is poor; when they purchase the item infrequently or are new to the category; and when

product designs vary over time, prices vary seasonally, or quality or sizes vary across stores.16 They

are less effective the more they are used. Limited availability (for example, “three days only”) also can

spur sales among consumers actively shopping for a product.17 Setting the Price A firm must set a price for the first time when it develops a new product, when it introduces its regular

product into a new distribution channel or geographic area, and when it enters bids on new contract

work. The firm must decide where to position its product on quality and price.18 Most markets have three to five price points or tiers. Marriott Hotels is good at developing different

brands or variations of brands for different price points: JW Marriott (highest price), Marriott Marquis

(high price), Marriott (high-medium price), Renaissance (medium-high price), Courtyard (medium

price), TownePlace Suites (medium-low price), and Fairfield Inn (low price). Firms devise their branding

strategies to help convey to consumers the price–quality tiers of their products or services.19 The firm must consider many factors in setting its pricing policy. The pricing process involves six

main steps: defining the pricing objective; determining demand; estimating costs; analyzing competi- tors’ costs, prices, and offers; selecting a pricing method; and setting the final price. << Despite booming

demand, Ferrari limits

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DESIGNING VALUE DEFINING THE PRICING OBJECTIVE An offering’s price is determined by a firm’s overall pricing objective. The clearer a firm’s objective,

the easier it is to set price. Four common pricing objectives are current profit, market penetration,

market skimming, and quality leadership. • Short-term profit. Many companies try to set a price that will maximize current profits. They esti- mate the demand and costs associated with alternative prices and choose the price that produces

maximum current profit, cash flow, or rate of return on investment. This strategy assumes the firm

knows its demand and cost functions, but in reality, these are difficult to estimate. Furthermore, in

emphasizing current performance, the company may sacrifice long-run performance by ignoring

the effects of other marketing variables, competitors’ reactions, and legal restraints on price. • Market penetration. Companies that choose penetration pricing want to maximize their market

share. They believe a higher sales volume will lead to lower unit costs and higher long-run profit, so

they set a very low price, assuming the market is price sensitive. Texas Instruments famously prac- ticed this market-penetration pricing for years. The company would build a large plant, set its price as

low as possible, win a large market share, experience falling costs, and cut its price further as costs fell. The following conditions favor adopting a market-penetration pricing strategy: (1) the market

is highly price sensitive, and a low price stimulates market growth; (2) production and distribu- tion costs fall with accumulated production experience; and (3) a low price discourages actual

and potential competition. • Market skimming. Companies unveiling a new technology favor setting high prices to maximize

market skimming. In market skimming, a company is setting a relatively high price in an attempt

to “skim the cream” off the market by making the offering affordable only to customers with the

highest willingness to pay. Sony has been a frequent practitioner of market-skimming pricing, in

which prices start high and slowly drop over time. Market skimming is beneficial under the following conditions: (1) a sufficient number of

buyers signal a high current demand; (2) the high initial price does not attract more competitors

to the market; and (3) the high price communicates the image of a superior product. • Quality leadership. A company might aim to be the quality leader in the market. To maintain quality

leadership, a company must charge a relatively high price in order to be able to invest in research and

development, production, and service delivery. Brands such as Starbucks, Aveda, Victoria’s Secret,

BMW, and Viking have positioned themselves as quality leaders in their categories, combining quality,

luxury, and premium prices with an intensely loyal customer base. Grey Goose and Absolut carved

out a super-premium niche in the essentially odorless, colorless, and tasteless vodka category through

clever on-premise and off-premise marketing that made the brands seem hip and exclusive. Nonprofit and public organizations may have other pricing objectives. A university aims for par- tial cost recovery, knowing that it must rely on private gifts and public grants to cover its remaining

costs. A nonprofit hospital may aim for full cost recovery in its pricing. A nonprofit theater company

may price its productions to fill the maximum number of seats. A social service agency may set a

service price geared to client income. Whatever the specific objective, businesses that use price as a strategic tool will profit more than

those that simply let costs or the market determine their pricing. For art museums, which earn an aver- age of only 5 percent of their revenues from admission charges, pricing can send a message that affects

their public image and the amount of donations and sponsorships they receive. DETERMINING DEMAND Each price will lead to a different level of demand and have a different impact on a company’s market- ing objectives. The normally inverse relationship between price and demand is captured in a demand

curve: The higher the price, the lower the demand. For prestige goods, the demand curve sometimes

slopes upward. Some consumers take the higher price to signify a better product. However, if the

price is too high, demand may fall. To estimate the demand for a company’s offering, marketers need to know how responsive, or elas- tic, demand is to a change in price. Price elasticity of demand reflects the degree to which a change

in price leads to a change in quantity sold. The lower the price elasticity, the less sensitive consumers

are to price increases, and the more likely it is that raising the price can increase sales revenues.20 Consider the two demand curves in Figure 11.1. In demand curve (a), a price increase from $10

to $15 leads to a relatively small decline in demand from 105 to 100. In demand curve (b), the same

price increase leads to a substantial drop in demand from 150 to 50. If demand hardly changes with a

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