Pricing Objectives

Survival

Most executives pursue strategies that align pricing with revenue generation, enabling their organizations to survive and thrive long term.

Learning Objectives

Name the different factors that impact a company’s success and survival

Key Takeaways

Key Points

  • New and improved products may hold the key to a firm’s survival and ultimate success.
  • All business enterprises must earn a long term profit in order to survive in the long run.
  • Just as survival requires a long term profit for a business enterprise, profit requires sales. Sales patterns should be altered to ensure success.
  • Management of all firms, large and small, are concerned with maintaining an adequate share of the market so their sales volume will enable the firm to survive and prosper. Prices must be set to attract the appropriate market segment in significant numbers.

Key Terms

  • Market Share: The percentage of a market (defined in terms of either units or revenue) accounted for by a specific entity.

Survival

Firms rely on price to cover the costs of production, pay expenses, and provide the profit incentive necessary to continue to operate the business. These factors help an organization survive. Most managers pursue strategies that enable their organizations to continue in operation for the long term. Thus, survival is one major objective pursued by company executives. For a commercial firm, the price paid by the buyer generates the firm’s revenue. If revenue falls below cost for a long period of time, the firm cannot survive. Survival is closely linked to new product development, profit, sales, market share, and image.

New Products

For several decades, business has come increasingly to the realization that new and improved products may hold the key to their survival and ultimate success. Consequently, professional management has become an integral part of this process. As a result, many firms develop new products based on an orderly procedure, employing comprehensive and relevant data and intelligent decision-making.The continuing development of a successful new product looms as the most important factor in the survival of the firm.

Profit

Making a $500,000 profit during the next year might be a pricing objective for a firm. Anything less will ensure failure. All business enterprises must earn a long term profit. For many businesses, long term profitability also allows the business to satisfy company stakeholders such as investors, employees, customers, and suppliers. Lower-than-expected or no profits will drive down stock prices and may prove disastrous for the company.

Sales

Just as survival requires a long term profit for a business enterprise, profit requires sales. The task of marketing management relates to managing demand. Demand must be managed in order to regulate exchanges or sales. Thus, marketing management’s aim is to alter sales patterns in some desirable way.

Market Share

If the sales of Safeway Supermarkets in the Dallas-Fort Worth metropolitan area of Texas account for 30 percent of all food sales in that area, we say that Safeway has a 30 percent market share. Management of all firms, large and small, are concerned with maintaining an adequate share of the market so their sales volume will enable the firm to survive and prosper. Again, pricing strategy is one of the tools that is significant in creating and sustaining market share. Prices must be set to attract the appropriate market segment in significant numbers.

Image

Price policies play an important role in affecting a firm’s position of respect and esteem in its community. Price is a highly visible communicator. It must convey the message to the community that the firm offers good value, that it is fair in its dealings with the public, that it is a reliable place to patronize, and that it stands behind its products and services.

A picture of a McDonald's restaurant.

Surviving the Recession: Pricing plays a significant role in attracting and retaining market share during tough economic times.

Profit

If the sole objective of a firm is to maximize profit, there are various profit maximizing pricing methods that can be used.

Learning Objectives

Recall formulas for calculating profit maximizing output quantity and marginal profit

Key Takeaways

Key Points

  • In launching new products or considering the pricing of current products, managers often start with an idea of the dollar profit they desire and ask what level of sales will be needed to reach it. This can be done through profit-based sales targets.
  • Profit is equal to total revenue (TR) minus total cost (TC). The profit maximizing output is the one at which this difference reaches its maximum. The corresponding price will depend on whether the firm is a perfect competitor. This is the TR-TC method.
  • Marginal profit (Mπ) equals marginal revenue (MR) minus marginal cost (MC). If MR is greater than MC at some level of output, marginal profit is positive and thus a greater quantity should be produced. When MR = MC, Mπ is zero and this quantity is the one that maximizes profit.

Key Terms

  • marginal revenue: Marginal revenue is the additional revenue that will be generated by increasing product sales by one unit.
  • Total Revenue: Total revenue is the total receipts of a firm from the sale of any given quantity of a product.
  • Total cost: Total cost (TC) describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labor and raw materials, plus fixed costs, which are independent of the quantity of a good produced and include inputs (capital) that cannot be varied in the short term, such as buildings and machinery.

Profit and Pricing Objectives

Some firms decide to set prices to maximize profits for either the short run or the long run. There are several methods to maximizing profits:

Profit-based Sales Targets

In launching new products or considering the pricing of current products, managers often start with an idea of the dollar profit they desire and ask what level of sales will be needed to reach it. Target volume (#) is the unit sales quantity needed to meet an earnings goal. Target revenue ($) is the corresponding figure for dollar sales. Increasingly, marketers are expected to generate volumes that meet the target profits of their firm. This will often require them to revise sales targets as prices and costs change.

The purpose of profit-based sales target metrics is to ensure that marketing and sales objectives mesh with profit targets. In target volume and target revenue calculations, managers go beyond break-even analysis (the point at which a company sells enough to cover its fixed costs) to determine the level of unit sales or revenues needed to cover a firm’s costs and attain its profit targets.

The Total Cost Method

To obtain the profit maximizing output quantity, you start by recognizing that profit is equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. The profit maximizing output is the one at which this difference reaches its maximum. In, the linear total revenue curve represents the case in which the firm is a perfect competitor in the goods market, and thus cannot set its own selling price. The profit maximizing output level is represented as the one at which total revenue is the height of C and total cost is the height of B; the maximal profit is measured as CB. This output level is also the one at which the total profit curve is at its maximum. If, contrary to what is assumed in the graph, the firm is not a perfect competitor in the output market, the price to sell the product at can be read off the demand curve at the firm’s optimal quantity of output.

A revenue curve that shows total profit maximization based on total cost and total revenue.

Total Profit Maximization: This linear total revenue curve represents the case in which the firm is a perfect competitor in the goods market. As a result, it cannot set its own selling price.

The Marginal Cost Perspective

An alternative perspective relies on the relationship that, for each unit sold, marginal profit (Mπ) equals marginal revenue (MR) minus marginal cost (MC). Then, if marginal revenue is greater than marginal cost at some level of output, marginal profit is positive and thus a greater quantity should be produced, and if marginal revenue is less than marginal cost, marginal profit is negative and a lesser quantity should be produced. At the output level at which marginal revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes profit. Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero – or where marginal cost equals marginal revenue – and where lower or higher output levels give lower profit levels.

Return on Investment

Marketers should understand the position of their company and the returns expected when making adjustments in prices.

Learning Objectives

Explain why pricing objectives focus on delivering a return on investment (ROI)

Key Takeaways

Key Points

  • Return on investment is one way of considering profits in relation to capital invested.
  • Marketing not only influences net profits but also can affect investment levels, too. New plants and equipment, inventories, and accounts receivable are three of the main categories of investments that can be affected by marketing decisions.
  • ROI provides a snapshot of profitability adjusted for the size of the investment assets tied up in the enterprise.

Key Terms

  • accounts receivable: Accounts receivable refers to the money owed to a business by its clients (customers) and shown on its balance sheet as an asset.
  • receivables: All the debts owed to a company by its debtors or customers.

Pricing objectives or goals give direction to the whole pricing process. Determining what your objectives are is the first step in pricing. When deciding on pricing objectives, you must consider:

1. The overall financial, marketing, and strategic objectives of the company

2. The objectives of your product or brand

3. Consumer price elasticity and price points

4. The resources you have available

One of the most common pricing objectives is obtaining a target rate of return on investment (ROI). Return on investment is one way of considering profits in relation to the capital invested. Marketing not only influences net profits but also can affect investment levels, too. New plants and equipment, inventories, and accounts receivable are three of the main categories of investments that can be affected by marketing decisions. Hence, it is important to keep all investments in mind when setting prices. It doesn’t pay to be narrow in focus.

The purpose of the return on investment metric is to measure per period rates of return on dollars invested in an economic entity. For example, this chart shows the rate of return on investments after training teachers. It provides a snapshot of profitability adjusted for the size of the investment assets tied up in the enterprise. Marketing decisions, such as setting prices, have obvious potential connection to the return on investment, but these same decisions often influence asset usage and capital requirements (for example, receivables and inventories). Marketers should understand the position of their company and the returns expected. Return on investment is often compared to expected (or required) rates of return on dollars invested.

A chart that shows the return on equity per person over three years after training teachers. It looks at the cost, savings, quality gains, and marketing gains.

Return on Investments: The chart shows the rate of return on investments after training teachers.

Market Share/Sales

Increasing market share is one of the most important objectives of business and pricing may offer a mechanism to increase share.

Learning Objectives

Explain the relationship between market share and pricing strategies

Key Takeaways

Key Points

  • Marketers need to be able to translate sales targets into market share because this will determine whether forecasts are to be attained by growing with the market or by capturing share from competitors.
  • Market share is a key indicator of market competitiveness—that is, how well a firm is doing compared to its competitors. It enables them to judge not only total market growth or decline but also trends in customers’ selections among competitors.
  • Losses in market share can signal serious long-term problems that require strategic adjustments. Firms with market shares below a certain level may not be viable.

Key Terms

  • Market Share: The percentage of a market (defined in terms of either units or revenue) accounted for by a specific entity.

Market share is a key indicator of market competitiveness—that is, how well a firm is doing compared to its competitors. It enables them to judge not only total market growth or decline but also trends in customers’ selections among competitors. Generally, sales growth resulting from primary demand (total market growth) is less costly and more profitable than that achieved by capturing share from competitors. Conversely, losses in market share can signal serious long-term problems that require strategic adjustments. Firms with market shares below a certain level may not be viable. Similarly, within a firm’s product line, market share trends for individual products are considered early indicators of future opportunities or problems.

Just as survival requires a long-term profit for a business enterprise, profit requires sales. The task of marketing management relates to managing demand. Demand must be managed in order to regulate exchanges or sales. Thus marketing management’s aim is to alter sales patterns in some desirable way. They are concerned with maintaining an adequate share of the market so that their sales volume will enable the firm to survive and prosper. Again, pricing strategy is one of the tools that is significant in creating and sustaining market share. Prices must be set to attract the appropriate market segment in significant numbers. Decreasing price may increase demand and lead to higher market share, though it could also provoke a competitive response.

A Netflix envelope and DVD.

Pricing Strategies: Changing the pricing strategy might be part of a longer-term strategy to increase market share in on-line video streaming.

Marketers need to be able to translate sales targets into market share because this will determine whether forecasts should be attained by growing with the market or by capturing share from competitors. The latter will almost always be more difficult to achieve. Market share is closely monitored for signs of change in the competitive landscape, and it frequently drives strategic or tactical decisions. Increasing market share is one of the most important objectives of business. The main advantage of using market share as a measure of business performance is that it is less dependent upon macro environmental variables such as the state of the economy or changes in tax policy.

Cash Flow

Cash flow is extremely important to firms as this is how they buy goods, pay employees, fund new investments, and pay dividends.

Learning Objectives

Identify the different pricing strategies for generating cash flow in an organization

Key Takeaways

Key Points

  • Some companies will set prices so that they can recover cash flow as quickly as possible. This strategy could be due to the company spending too much of its resources on developing products.
  • One way to get cash flow quickly is through seasonal discounts. Seasonal discounts are price reductions given on out-of-season merchandise.
  • Another option is cash discounts. Cash discounts are reductions on the base price given to customers for paying cash or within some short time period.

Key Terms

  • seasonal discount: price reductions given when an order is placed in a slack period
  • cash flow: The movement of money into or out of a business.

Cash flow is the movement of money into or out of a business. The measurement of cash flow can be used for calculating other parameters that give information on a company’s value and situation. Some companies will set prices so that they can recover cash flow as quickly as possible. This strategy could be due to the company spending too much of its resources on developing products. This typically requires setting prices very high, which is a disadvantage since competitors can set prices lower and gain a larger market share.

Seasonal Sales : A quick way to generate cash flow is to offer seasonal discounts.

Cash flow is extremely important to a firm. This is how they buy goods, pay employees, fund new investments, and pay dividends. It is necessary to determine the effects of pricing on cash flow to a firm.

One way to get cash flow quickly is through seasonal discounts. Seasonal discounts are price reductions given for out-of-season merchandise. An example would be a discount on snowmobiles during the summer. The intention of such discounts is to spread demand over the year. This can allow for the fuller use of production facilities and improved cash flow throughout the year.

Another option is cash discounts. Cash discounts are reductions on the base price given to customers for paying cash or within some short time period. For example, a company can give a two percent discount on bills paid within 10 days. Another example is a gas station that gives discounts on gas prices to costumers who don’t pay with credit cards. The purpose is generally to accelerate the cash flow of the organization.

Status Quo

Status quo pricing is the concept that some goods within certain industries have an expected price for consumers, due to a relative norm within that market.

Learning Objectives

Recognize that some product types have relative consistent pricing, and entering those markets often requires the ability to produce at that price or lower

Key Takeaways

Key Points

  • Many products and services have relatively normal expected prices, usually due to a balance of demand, competition, and economic factors.
  • In order to effectively compete in those markets, organizations must refine their process to produce at the status quo price point or lower in order to satisfy the needs of consumers in that market.
  • Status quo price points usually evolve organically as a byproduct of external and competitive forces.
  • It is important to differentiate price fixing and status quo pricing. Price fixing is an agreement among competitive firms to set prices at the same level in order to attain a monopoly. This is illegal under antitrust laws in most countries.

Key Terms

  • status quo: The state of things; the way things are, as opposed to the way they could be; the existing state of affairs.
  • price fixing: An agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.

When setting a price for a given product or service, there are countless objectives an organization may have that will impact how and why a price is determined. While there are too many objectives to provide a comprehensive list, some of the more common pricing objectives include:

  • Maximizing short-term or long-term profit
  • Increasing sales volume
  • Increasing market share and/or growth
  • Becoming a price leader
  • Differentiating for a niche segment
  • Social, ethical, or ideological objectives (e.g. making something available to consumers with lower incomes)
  • Attaining the competitive equilibrium

Many industries have key competitors that wield a great deal of power and influence within the industry. As a result, new entrants and smaller players are often forced to attain a similar efficiency in operations and become able to sell a given good at a specific price or lower. These larger, strong players often have scale economies, which slowly make the ‘status quo’ price of a given good lower than is obtainable by other incumbents.

Status Quo Pricing

As a result of this, some firms pursue status quo pricing as a pricing objective. In this situation, they assess the overall market to determine what the going prices are for the product or service they will sell. Once this price point is established, the organization will strive to build an operational mechanism that enables the organization to be profitable at the price point (or possibly lower). This objective is particularly useful when applied to mature industries with firmly set price points and a low variance in price elasticity in the consumer groups.

These status quo price points arise organically, based on consumer behavior, competitive factors, and the price of production. Status quo prices are often associated with homogeneous goods for which the price has been lowered significantly through competition.

Price Fixing

An extremely important ethical consideration of this pricing objective is avoidance of price fixing. Price fixing is the illegal practice of various competitive firms within an industry agreeing on a fixed price for goods within an industry. If all competitive firms agree on price, there is no real practical different for the consumer between this and a monopoly.

The purpose of price fixing is identifying the highest possible optimal price point that can be charged for a given good within a market, which will in turn benefit all of the providers of that good. This is a criminal offense in the United States and can be prosecuted under the Sherman Antitrust Act.

Product Quality

Quality refers to the ability of a product or service to consistently meet or exceed customer requirements or expectations.

Learning Objectives

Identify the different aspects and determinants of product quality

Key Takeaways

Key Points

  • Some of these consequences of poor quality include loss of business, liability, decreased productivity, and increased costs.
  • Good quality has its own costs, including prevention, appraisal, and failure.
  • Successful management of quality requires that managers have insights on various aspects of quality such as understanding the costs and benefits of quality and recognizing the consequences of poor quality.
  • Understanding the determants of quality, such as design of the product and the “ease of use” of the product, will help managers price the products accordingly.

Key Terms

  • return on quality: An internal management approach that evaluates the financial return of investments in quality.
  • quality: The ability of a product or service to consistently meet or exceed customer requirements or expectations.

Broadly defined, quality refers to the ability of a product or service to consistently meet or exceed customer requirements or expectations. Different customers will have different expectations, so a working definition of quality is customer-dependent. When discussing quality one must consider design, production, and service. In a culmination of efforts, it begins with careful assessment of what the customers want, then translating this information into technical specifications to which goods or services must conform. The specifications guide product and service design, process design, production of goods and delivery of services, and service after the sale or delivery.

Some of these consequences of poor quality include loss of business, liability, decreased productivity, and increased costs. However, good quality has its own costs, including prevention, appraisal, and failure. A recent and more effective approach is discovering ways to prevent problems, instead of trying to fix them once they occur. This will ultimately decrease the cost of good quality in the long run.

There are several costs associated with quality:

  • Appraisal costs – costs of activities designed to ensure quality or uncover defects
  • Prevention costs – costs of prevention defects from occurring
  • Failure costs – Costs caused by defective parts or products or by faulty services
  • Internal failures – failures discovered during production
  • External failures – failures discovered after delivery to the customer
  • Return on quality (ROQ) – an approach that evaluates the financial return of investments in quality

Successful management of quality requires that managers have insights on various aspects of quality. These include defining quality in operational terms, understanding the costs and benefits of quality, recognizing the consequences of poor quality and recognizing the need for ethical behavior. Understanding dimensions that customers use to judge the quality of a product or service helps organizations meet customer expectations.

Dimensions of Product Quality

  • Performance– main characteristics of the product
  • Aesthetics– appearance, feel, smell, taste
  • Special features– extra characteristics
  • Conformance – how well the product conforms to design specifications
  • Reliability– consistency of performance
  • Durability– the useful life of the product
  • Perceived quality– indirect evaluation of quality
  • Service-ability– handling of complaints or repairs

Determinants of Quality

  1. Quality of Design – intention of designers to include or exclude features in a product or service. The starting point of producing quality in products begins in the “design phase”. Designing decisions may involve product or service size, shape and location. When making designs, designers must keep in mind customer wants, production or service capabilities, safety and liability, costs, and other similar considerations.
  2. Quality of conformance – refers to the degree to which goods and services conform to the intent of the designer. Quality of conformance can easily be affected by factors like: capability of equipment used, skills, training, and motivation of workers, extent to which the design lends itself to production, the monitoring process to assess conformance, and the taking of corrective action.
  3. Ease of use – refers to the ease of usage of the product or services for the customers. The term “ease of use” refers to user instructions. Designing a product with “ease of use” increases the chances that the product will be used in its intended design and it will continue to function properly and safely. Without ease of use, companies may lose customers, face sales returns, or legal problems from product injuries. Ease of use also applies to services. Manufacturers must make sure that directions for unpacking, assembling, using, maintaining, and adjusting the product are included. Directions for “What to do when something goes wrong” should also be included. Ease of use makes a consumer very happy and can help retain customers.
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High-quality cars: The Mercedes-Benz SLR McLaren has a reputation for extremely high quality. Its handmade engine is a sign of the quality.