Pricing a Product

Pricing a Product Learning Objective Identify pricing strategies that are appropriate for new and existing products. Question #3 The second of the four Ps in the marketing mix is price. Pricing a product involves a certain amount of trial and error because there are so many factors to consider. If you price too high, a lot of people simply won’t buy your product. Or you might find yourself facing competition from some other supplier who feels that it can beat your price. On the other hand, if you price too low, you might not make enough profit to stay in business. So how do you decide on a price? Let’s look at several pricing options that were available to the marketers at Wow Wee who were responsible for pricing Robosapien. We’ll begin by discussing two strategies that are particularly applicable to products that are being newly introduced.
New Product Pricing Strategies Right now, Robosapien has little direct competition in its product category. True, there are some “toy” robots available, but they’re not nearly as sophisticated. Sony makes a pet dog robot called Aibo, but its price tag of $1,800 is pretty high. Even higher up the price-point scale is the $3,600 iRobi robot made by the Korean company Yujin Robotics to entertain kids and even teach them foreign languages. Parents can also monitor kids’ interactions with the robot through its own video-camera eyes; in fact, they can even use the robot itself to relay video messages telling kids to shut it off and go to sleep. Cliff Edwards, “Ready to Buy a Home Robot?” Business Week, July 19, 2004, 84–90.
Skimming and Penetration Pricing Because Wow Wee is introducing an innovative product in an emerging market with few direct competitors, it might consider one of two pricing strategies: With skimming pricing, Wow Wee would start off with the highest price that keenly interested customers would pay. This approach would generate early profits, but when competition enters—and it will, because healthy profits can be made in the market—Wow Wee would have to lower its price. Using penetration pricing, Wow Wee would initially charge a low price, both to discourage competition and to grab a sizeable share of the market. This strategy might give the company some competitive breathing room (potential competitors won’t be attracted to low prices and modest profits). Over time, as its growing market discourages competition, Wow Wee can push up its prices.
Other Pricing Strategies In their search for the best price level, Wow Wee’s marketing managers could consider a variety of other approaches, such as cost-based pricing, demand-based pricing, target costing, odd-even pricing, and prestige pricing. Any of these methods could be used not only to set an initial price but to establish long-term pricing levels. Before we examine these strategies, let’s pause for a moment to think about the pricing decisions that you have to make if you’re selling goods for resale by retailers. Most of us think of price as the amount that we—consumers—pay for a product. But when a manufacturer (such as Wow Wee) sells goods to retailers, the price it gets is not what we the consumers will pay for the product. In fact, it’s a lot less. Here’s an example. Say you buy a shirt at a store in the mall for $40. The shirt was probably sold to the retailer by the manufacturer for $20. The retailer then marks up the shirt by 100 percent, or $20, to cover its costs and to make a profit. The $20 paid to the manufacturer plus the $20 markup results in a $40 sales price to the consumer.
Cost-Based Pricing Using cost-based pricing, Wow Wee’s accountants would figure out how much it costs to make Robosapien and then set a price by adding a profit to the cost. If, for example, it cost $40 to make the robot, Wow Wee could add on $10 for profit and charge retailers $50.
Demand-Based Pricing Let’s say that Wow Wee learns through market research how much people are willing to pay for Robosapien. Following a demand-based pricing approach, it will use this information to set the price that it charges retailers. If consumers are willing to pay $120 retail, Wow Wee will charge retailers a price that will allow retailers to sell the product for $120. What would that price be? Here’s how we would arrive at it: $120 consumer selling price minus a $60 markup by retailers means that Wow Wee can charge retailers $60.
Target Costing With target costing, you work backwards. You figure out (again using research findings) how much consumers are willing to pay for a product. From this price—the selling price—you subtract an amount to cover your profit. This process should tell you how much you can spend to make the product. For example, Wow Wee determines that it can sell Robosapien to retailers for $70. The company decides that it wants to make $15 profit on each robot. Thus, Wow Wee can spend $55 on the product ($70 selling price to the retailer minus $15 profit means that the company can spend $55 to make each robot).
Prestige Pricing Some people associate a high price with high quality—and, in fact, there generally is a correlation. Thus, some companies adopt a prestige pricing approach—setting prices artificially high to foster the impression that they’re offering a high-quality product. Competitors are reluctant to lower their prices because it would suggest that they’re lower-quality products. Let’s say that Wow Wee finds some amazing production method that allows it to produce Robosapien at a fraction of its current cost. It could pass the savings on by cutting the price, but it might be reluctant to do so: What if consumers equate low cost with poor quality?
Odd-Even Pricing Do you think $9.99 sounds cheaper than $10? If you do, you’re part of the reason that companies sometimes use odd-even pricing—pricing products a few cents (or dollars) under an even number. Retailers, for example, might price Robosapien at $99 (or even $99.99) if they thought consumers would perceive it as less than $100.
Key Takeaways With a new product, a company might consider the skimming approach—starting off with the highest price that keenly interested customers are willing to pay. This approach yields early profits but invites competition. Using a penetration approach, marketers begin by charging a low price, both to keep out competition and to grab as much market share as possible. Several strategies work for existing as well as new products. With cost-based pricing, a company determines the cost of making a product and then sets a price by adding a profit to the cost. With demand-based pricing, marketers set the price that they think consumers will pay. Using target costing, they figure out how much consumers are willing to pay and then subtract a reasonable profit from this price to determine the amount that can be spent to make the product. Companies use prestige pricing to capitalize on the common association of high price and quality, setting an artificially high price to substantiate the impression of high quality. Finally, with odd-even pricing, companies set prices at such figures as $9.99 (an odd amount), counting on the common impression that it sounds cheaper than $10 (an even amount). Exercise AACSB Communication Most calculators come with a book of instructions. Unfortunately, if you misplace the book, you’re left to your own devices in figuring out how to use the calculator. Wouldn’t it be easier if the calculator had a built-in “help” function similar to the one on your computer? You could just punch the “Help” key on your keypad and call up the relevant instructions on your display screen. You just invented a calculator with this feature, and you’re ready to roll it out. First, however, you have to make some pricing decisions: When you introduce the product, should you use skimming or penetration pricing? Which of the following pricing methods should you use in the long term: cost-based pricing, demand-based pricing, target costing, or prestige pricing? Prepare a report describing both your introductory and long-term alternatives. Then explain and justify your choice of the methods that you’ll use. skimming pricing Pricing strategy in which a seller generates early profits by starting off charging the highest price that customers will pay. penetration pricing Pricing strategy in which the seller charges a low price on a new product to discourage competition and gain market share. cost-based pricing Pricing strategy that bases the selling price of a product on its cost plus a reasonable profit. demand-based pricing Practice strategy that bases the price of a product on how much people are willing to pay for it. target costing Practice strategy that determines how much to invest in a product by figuring out how much customers will pay and subtracting an amount for profit. prestige pricing Practice of setting a price artificially high to foster the impression that it is a product is of high-quality. odd-even pricing Practice of pricing products a few cents (or dollars) under an even number.