Texas A & M University Kingsville Marketing Management Discussion

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After reviewing Chapter 10 and 11 from the textbook, post a 700-word synopsis of your understanding of the marketing concepts. Complete the assignment in APA format and refer to the attached textbook and let me know if you have any questions.

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Chapter 10 Distribution Strategy Channel of distribution decisions involve numerous interrelated variables that must be integrated into the total marketing mix. Because of the time and money required to set up an efficient channel, and since channels are often hard to change once they are set up, these decisions are critical to the success of the firm. This chapter is concerned with the development and management of channels of distribution and the process of goods distribution in complex, highly competitive, and specialized economies. It should be noted at the outset that channels of distribution provide the ultimate consumer or organizational buyer with time, place, and possession utility. Thus, an efficient channel is one that delivers the product when and where it is wanted at a minimum total cost. THE NEED FOR MARKETING INTERMEDIARIES Part C A channel of distribution is the combination of institutions through which a seller markets products to organizational buyers or ultimate consumers. The need for other institutions or intermediaries in the delivery of goods is sometimes questioned, particularly since the profits they make are viewed as adding to the cost of the product. However, this reasoning is generally fallacious, since producers use marketing intermediaries because the intermediary can perform functions more cheaply and more efficiently than the producer can. This notion of efficiency is critical when the characteristics of advanced economies are considered. For example, the U.S. economy is characterized by heterogeneity in terms of both supply and demand. In terms of numbers alone, there are more than 7 million establishments with employees comprising the supply segment of the economy, and there are nearly 110 million households making up the demand side. Clearly, if each of these units had to deal on a one-to-one basis to obtain needed goods and services, and there were no intermediaries to collect and disperse assortments of goods, the system would be totally inefficient. Thus, the primary role of intermediaries is to bring supply and demand together in an efficient and orderly fashion. The Marketing Mix CLASSIFICATION OF MARKETING INTERMEDIARIES AND FUNCTIONS There are a great many types of marketing intermediaries, many of which are so specialized by function and industry that they need not be discussed here. Figure 10.1 presents the major types of marketing intermediaries common to many industries. Although there is some overlap in this classification, these categories are based on the marketing 156 Chapter Ten Distribution Strategy FIGURE 10.1 Major Types of Marketing Intermediaries Source: Based on Peter D. Bennett, ed., Dictionary of Marketing Terms, 2nd ed. (Chicago: American Marketing Association, 1995). 157 Middleman—an independent business concern that operates as a link between producers and ultimate consumers or organizational buyers. Merchant middleman—a middleman who buys the goods outright and takes title to them. Agent—a business unit that negotiates purchases, sales, or both but does not take title to the goods in which it deals. Wholesaler—a merchant establishment operated by a concern that is primarily engaged in buying, taking title to, usually storing and physically handling goods in large quantities, and reselling the goods (usually in smaller quantities) to retailers or to organizational buyers. Retailer—a merchant middleman who is engaged primarily in selling to ultimate consumers. Broker—a middleman who serves as a go-between for the buyer or seller. The broker assumes no title risks, does not usually have physical custody of products, and is not looked upon as a permanent representative of either the buyer or the seller. Manufacturers’ agent—an agent who generally operates on an extended contractual basis, often sells within an exclusive territory, handles noncompeting but related lines of goods, and possesses limited authority with regard to prices and terms of sale. Distributor—a wholesale middleman especially in lines where selective or exclusive distribution is common at the wholesaler level in which the manufacturer expects strong promotional support; often a synonym for wholesaler. Jobber—a middleman who buys from manufacturers and sells to retailers; a wholesaler. Facilitating agent—a business firm that assists in the performance of distribution tasks other than buying, selling, and transferring title (i.e., transportation companies, warehouses, etc.) functions performed; that is, various intermediaries perform different marketing functions and to different degrees. Figure 10.2 is a listing of the more common marketing functions performed in the channel. It should be remembered that whether or not a manufacturer uses intermediaries to perform these functions, the functions have to be performed by someone. In other words, the managerial question is not whether to perform the functions, but who will perform them and to what degree. FIGURE 10.2 Major Functions Performed in Channels of Distribution Source: From Roger Kerin, Steven Hartley and William Rudelius, Marketing 11E, 2013, p. 379. Reprinted with permission of McGraw-Hill Education. Transactional Function Buying: Purchasing products for resale or as an agent for supply of a product. Selling: Contacting potential customers, promoting products, and soliciting orders. Risk taking: Assuming business risks in the ownership of inventory that can become obsolete or deteriorate. Logistical Function Assorting: Creating product assortments from several sources to serve customers. Storing: Assembling and protecting products at a convenient location to offer better customer service. Sorting: Purchasing in large quantities and breaking into smaller amounts desired by customers. Transporting: Physically moving products to customers. Facilitating Function Financing: Extending credit to customers. Grading: Inspecting, testing, or judging products, and assigning them quality grades. Marketing information and research: Providing information to customers and suppliers, including competitive conditions and trends. 158 Part C The Marketing Mix CHANNELS OF DISTRIBUTION As previously noted, a channel of distribution is the combination of institutions through which a seller markets products to the user or ultimate consumer. Some of these links assume the risks of ownership; others do not. The conventional channel of distribution patterns for consumer goods markets are shown in Figure 10.3. Some manufacturers use direct channels, selling directly to a market. For example, Gateway sold computers through the mail without the use of other intermediaries. Using a direct channel, called direct marketing, increased in popularity as marketers found that products could be sold directly using a variety of methods. These include direct mail, telemarketing, direct-action advertising, catalog selling, cable selling, online selling, and direct selling through demonstrations at home or place of work. These will be discussed in more detail later in this chapter. In other cases, one or more intermediaries may be used in the distribution process. For example, Hewlett-Packard sells its computers and printers through retailers such as Best Buy and Office Max. A common channel for consumer goods is one in which the manufacturer sells through wholesalers and retailers. For instance, a cold remedy manufacturer may sell to drug wholesalers who, in turn, sell a vast array of drug products to various retail outlets. Small manufacturers may also use agents, since they do not have sufficient capital for their own sales forces. Agents are commonly used intermediaries in the jewelry industry. The final channel in Figure 10.3 is used primarily when small wholesalers and retailers are involved. Channels with one or more intermediaries are referred to as indirect channels. In contrast to consumer products, the direct channel is often used in the distribution of organizational goods. The reason for this stems from the structure of most organizational markets, which often have relatively few but extremely large customers. Also, many organizational products, such as computer systems, need a great deal of presale and postsale service. Distributors are used in organizational markets when there is a large number of buyers but each purchases a small amount of a product. As in the consumer market, agents are used FIGURE 10.3 Conventional Channels of Distribution of Consumer Goods Manufacturer Consumers Manufacturer Retailers Consumers Manufacturer Wholesaler Retailers Consumers Manufacturer Agent Retailers Consumers Wholesaler Retailers Consumers Manufacturer Agent Chapter Ten Distribution Strategy 159 FIGURE 10.4 Conventional Channels of Distribution for Organizational Goods Organizational users Manufacturer Manufacturer Organizational distributors Organizational users Manufacturer Agents Organizational users Organizational distributors Organizational users Manufacturer Agents in organizational markets in cases where manufacturers do not wish to have their own sales forces. Such an arrangement may be used by small manufacturers or when the market is geographically dispersed. The final channel arrangement in Figure 10.4 may also be used by a small manufacturer or when the market consists of many small customers. Under such conditions, it may not be economical for sellers to have their own sales organization. SELECTING CHANNELS OF DISTRIBUTION Given the numerous types of channel intermediaries and functions that must be performed, the task of selecting and designing a channel of distribution may at first appear to be overwhelming. However, in many industries, channels of distribution have developed over many years and have become somewhat traditional. In such cases, the producer may be limited to this type of channel to operate in the industry. This is not to say that a traditional channel is always the most efficient and that there are no opportunities for innovation. But the fact that such a channel is widely accepted in the industry suggests it is highly efficient. A primary constraint in these cases and in cases where no traditional channel exists is that of availability of the various types of middlemen. All too often in the early stages of channel design, executives map out elaborate channel networks only to find out later that no such independent intermediaries exist for the firm’s product in selected geographic areas. Even if they do exist, they may not be willing to accept the seller’s products. In general, there are six basic considerations in the initial development of channel strategy. These are outlined in Figure 10.5. It should be noted that for a particular product any one of these characteristics greatly influences choice of channels. To illustrate, highly perishable products generally require direct channels, or a firm with little financial strength may require intermediaries to perform almost all of the marketing functions. Specific Considerations The preceding characteristics play an important part in framing the channel selection decision. Based on them, the choice of channels can be further refined in terms of 160 Part C The Marketing Mix FIGURE 10.5 General Considerations in Channel Planning 1. Customer characteristics. a. Number. b. Geographic dispersion. c. Preferred channels and outlets for purchase. d. Purchasing patterns. e. Use of new channels (e.g., online purchasing). 2. Product characteristics. a. Unit value. b. Perishability. c. Bulkiness. d. Degree of standardization. e. Installation and maintenance services required. 3. Intermediary characteristics. a. Availability. b. Willingness to accept product or product line. c. Geographic market served. d. Marketing functions performed. e. Potential for conflict. f. Potential for long-term relationship. g. Competitive products sold. h. Financial condition. i. Other strengths and weaknesses. 4. Competitor characteristics. a. Number. b. Relative size and market share. c. Distribution channels and strategy. d. Financial condition and estimated marketing budget. e. Size of product mix and product lines. f. Overall marketing strategy employed. g. Other strengths and weaknesses. 5. Company characteristics. a. Relative size and market share. b. Financial condition and marketing budget. c. Size of product mix and product lines. d. Marketing strategy employed. e. Marketing objectives. f. Past channel experience. g. Marketing functions willing to perform. h. Other strengths and weaknesses. 6. Environmental characteristics. a. Economic conditions. b. Legal regulations and restrictions. c. Political issues. d. Global and domestic cultural differences and changes. e. Technological changes. f. Other opportunities and threats. (1) distribution coverage required, (2) degree of control desired, (3) total distribution cost, and (4) channel flexibility. Distribution Coverage Required Because of the characteristics of the product, the environment needed to sell the product, and the needs and expectations of the potential buyer, products will vary in the intensity of distribution coverage they require. Distribution coverage can be viewed along a continuum ranging from intensive to selective to exclusive distribution. Intensive Distribution Here the manufacturer attempts to gain exposure through as many wholesalers and retailers as possible. Most convenience goods require intensive distribution based on the characteristics of the product (low unit value) and the needs and expectations of the buyer (high frequency of purchase and convenience). Selective Distribution Here the manufacturer limits the use of intermediaries to the ones believed to be the best available in a geographic area. This may be based on the service organization available, the sales organization, or the reputation of the intermediary. Thus, appliances, home furnishings, and better clothing are usually distributed selectively. For appliances, the intermediary’s service organization could be a key factor, while for better clothing and home furnishings, the intermediary’s reputation would be an important consideration. Exclusive Distribution Here the manufacturer severely limits distribution, and intermediaries are provided exclusive rights within a particular territory. The characteristics of the product are a determining factor here. Where the product requires certain specialized selling effort or investment in unique facilities or large inventories, this arrangement is usually selected. Retail paint stores are an example of such a distribution arrangement. MARKETING INSIGHT Manufacturers and Intermediaries: A Perfect Working Relationship 10–1 THE PERFECT INTERMEDIARY 1. Has access to the market that the manufacturer wants to reach. 2. Carries adequate stocks of the manufacturer’s products and a satisfactory assortment of other products. 3. Has an effective promotional program—advertising, personal selling, and product displays. Promotional demands placed on the manufacturer are in line with what the manufacturer intends to do. 4. Provides services to customers—credit, delivery, installation, and product repair—and honors the product warranty conditions. 5. Pays its bills on time and has capable management. THE PERFECT MANUFACTURER 1. Provides a desirable assortment of products—well designed, properly priced, attractively packaged, and delivered on time and in adequate quantities. 2. Builds product demand for these products by advertising them. 3. Furnishes promotional assistance to its middlemen. 4. Provides managerial assistance for its middlemen. 5. Honors product warranties and provides repair and installation service. THE PERFECT COMBINATION 1. Probably doesn’t exist. Degree of Control Desired In selecting channels of distribution, the seller must make decisions concerning the degree of control desired over the marketing of the firm’s products. Some manufacturers prefer to keep as much control over their products as possible. Ordinarily, the degree of control achieved by the seller is proportionate to the directness of the channel. One Eastern brewery, for instance, owns its own fleet of trucks and operates a wholly owned delivery system direct to grocery and liquor stores. Its market is very concentrated geographically, with many small buyers, so such a system is economically feasible. However, all other brewers in the area sell through distributors. When more indirect channels are used, the manufacturer must surrender some control over the marketing of the firm’s product. However, attempts are commonly made to maintain a degree of control through some other indirect means, such as sharing promotional expenditures, providing sales training, or other operational aids, such as accounting systems, inventory systems, or marketing research data on the dealer’s trading area. Total Distribution Cost The total distribution cost concept has developed out of the more general topic of systems theory. The concept suggests that a channel of distribution should be viewed as a total system composed of interdependent subsystems, and that the objective of the system (channel) manager should be to optimize total system performance. In terms of distribution costs, it generally is assumed that the total system should be designed to minimize costs for a given level of service. The following is a representative list of the major distribution costs to be minimized: 1. Transportation. 2. Order processing. 161 162 Part C The Marketing Mix 3. Cost of lost business (an opportunity cost due to inability to meet customer demand). 4. Inventory carrying costs, including: a. Storage-space charges. b. Cost of capital invested. c. Taxes. d. Insurance. e. Obsolescence and deterioration. 5. Packaging. 6. Materials handling. The important qualification to the total-cost concept is the statement “other things being equal.” The purpose of the total-cost concept is to emphasize total system performance to avoid suboptimization. However, other important factors must be considered, not the least of which are level of customer service, sales, profits, and interface with the total marketing mix. Channel Flexibility A final consideration relates to the ability of the manufacturer to adapt to changing conditions. To illustrate, much of the population has moved from inner cities to suburbs, and thus buyers make most of their purchases in shopping centers and malls. If a manufacturer had long-term exclusive dealership with retailers in the inner city, the ability to adapt to this population shift could have been severely limited. MANAGING A CHANNEL OF DISTRIBUTION Once the seller has decided on the type of channel structure to use and selected the individual members, the entire coalition should operate as a total system. From a behavioral perspective, the system can be viewed as a social system since each member interacts with the others, each member plays a role vis-à-vis the others, and each has certain expectations of the other. Thus, the behavioral perspective views a channel of distribution as more than a series of markets or participants extending from production to consumption. Relationship Marketing in Channels For many years in theory and practice, marketing has taken a competitive view of channels of distribution. In other words, since channel members had different goals and strategies, it was believed that the major focus should be on concepts such as power and conflict. Research interests focused on issues concerning bases of power, antecedents and consequences of conflict, and conflict resolution. More recently, however, a new view of channels has developed. Perhaps because of the success of Japanese companies in the 1980s, it was recognized that much could be gained by developing long-term commitments and harmony among channel members. This view is called relationship marketing, which can be defined as “marketing with the conscious aim to develop and manage long-term and/or trusting relationships with customers, distributors, suppliers, or other parties in the marketing environment.”1 It is well documented in the marketing literature that long-term relationships throughout the channel often lead to higher-quality products with lower costs. These benefits may account for the increased use of vertical marketing systems.2 Vertical Marketing Systems To this point in the chapter, the discussion has focused primarily on conventional channels of distribution. In conventional channels, each firm is relatively independent of the other Chapter Ten Distribution Strategy FIGURE 10.6 163 Vertical marketing systems Major Types of Vertical Marketing Systems Administered systems Contractual systems Corporate systems members in the channel. However, one of the important developments in channel management in recent years is the increasing use of vertical marketing systems. Vertical marketing systems are channels in which members are more dependent on one another and develop long-term working relationships in order to improve the efficiency and effectiveness of the system. Figure 10.6 shows the major types of vertical marketing systems, which include administered, contractual, and corporate systems.3 Administered Systems Administered vertical marketing systems are the most similar to conventional channels. However, in these systems there is a higher degree of interorganizational planning and management than in a conventional channel. The dependence in these systems can result from the existence of a strong channel leader such that other channel members work closely with this company in order to maintain a long-term relationship. While any level of channel member may be the leader of an administered system, Walmart, Kmart, and Sears are excellent examples of retailers that have established administered systems with many of their suppliers. Contractual Systems Contractual vertical marketing systems involve independent production and distribution companies entering into formal contracts to perform designated marketing functions. Three major types of contractual vertical marketing systems are the retail cooperative organization, wholesaler-sponsored voluntary chain, and various franchising programs. In a retail cooperative organization, a group of independent retailers unite and agree to pool buying and managerial resources to improve competitive position. In a wholesaler-sponsored voluntary chain, a wholesaler contracts with a number of retailers and performs channel functions for them. Usually, retailers agree to concentrate a major portion of their purchasing with the sponsoring wholesaler and to sell advertised products at the same price. The most visible type of contractual vertical marketing systems involves a variety of franchise programs. Franchises involve a parent company (the franchisor) and an independent firm (the franchisee) entering into a contractual relationship to set up and operate a business in a particular way. Many products and services reach consumers through franchise systems, including automobiles (Ford), gasoline (Mobil), hotels and motels (Holiday Inn), restaurants (McDonald’s), car rentals (Avis), and soft drinks (Pepsi). In fact, some analysts predict that within the next 10 years, franchises will account for 50 percent of all retail sales. Corporate Systems Corporate vertical marketing systems involve single ownership of two or more levels of a channel. A manufacturer’s purchasing wholesalers or retailers is called forward MARKETING INSIGHT Advantages and Disadvantages of Franchising 10–2 A franchise is a means by which a producer of products or services achieves a direct channel of distribution without wholly owning or managing the physical facilities in the market. In effect, the franchisor provides the franchisee with the marketing, management, operations, financial, and accounting know-how and skills to run a business in exchange for a financial return. Usually, the franchisee pays an initial fee plus a percentage of sales to the franchisor. Some of the top franchises are Hampton Hotels, Subway, 7-Eleven, Servpro, Days Inn, McDonald’s, Denny’s, H&R Block, Pizza Hut, and Dunkin Donuts. This form of contractual vertical marketing system has a number of advantages for the franchisor compared with a company-owned chain: • It allows rapid expansion requiring less capital resulting in faster market penetration and higher profits. • It requires fewer company managers and employees, thus lowering costs. • Franchisees may have greater motivation to make the business a success than employees of a company-owned store. • It is easier to penetrate global markets as local franchisees should better understand the culture and the market. • Opportunities exist for additional profits on supplies sold to franchisees. However, there are also some disadvantages: • Brand equity of the whole franchise could be damaged if even a few of the franchisees provide poor service or mistreat customers. • There is dependence on franchisees for financial success without full control of them. • There may be resistance from existing franchisees to expanding the number of new outlets in a market because their sales could be lowered. • There may be difficulty managing unhappy franchisees if sales are low or slowing, which can discourage new franchisee applicants. • There may be possible legal exposure from illegal or unsafe activities by franchisees, such as contaminated food or poor auto repair service resulting in an accident. Sources: Dhruv Grewal and Michael Levy, Marketing, 4th ed. (Burr Ridge, IL: McGraw-Hill, 2014), pp. 492– 493; Julian Dent, Distribution Channels, 2nd ed. (London: Kogan Page, 2011), pp. 330–331. integration. Wholesalers or retailers’ purchasing channel members above them is called backward integration. Firms may choose to develop corporate vertical marketing systems in order to compete more effectively with other marketing systems, to obtain scale economies, and to increase channel cooperation and avoid channel conflict. WHOLESALING As noted, wholesalers are merchants that are primarily engaged in buying, taking title to, usually storing and physically handling goods in large quantities, and reselling the goods (usually in smaller quantities) to retailers or to industrial or business users.4 Wholesalers are also called distributors in some industries, particularly when they have exclusive distribution rights, such as in the beer industry. Other wholesalers that do not take title to goods are called agents, brokers, or manufacturers’ representatives in various industries. There are more than 890,000 wholesalers in the United States. Wholesalers create value for suppliers, retailers, and users of goods by performing distribution functions efficiently and effectively. They may transport and warehouse goods, exhibit them at trade shows, and offer advice to retailers concerning which lines of 164 Chapter Ten Distribution Strategy 165 products are selling best in other areas. Producers use wholesalers to reach large markets and extend geographic coverage for their goods. Wholesalers may lower the costs for other channel members by efficiently carrying out such activities as physically moving goods to convenient locations, assuming the risk of managing large inventories of diverse products, and delivering products as needed to replenish retail shelves. While producers may actively seek out wholesalers for their goods, wholesalers also try to attract producers to use their services. To do so, they may offer to perform all the distribution functions or tailor their services to include only the functions that producers do not have the ability to perform effectively. Naturally, wholesalers especially seek producers of major brands for which sales and profit potential are likely to be the greatest. Wholesalers may compete with other wholesalers to attract producers by offering lower costs for the functions they perform. Wholesalers with excellent track records that do not carry directly competing products and brands, that have appropriate locations and facilities, and that have relationships with major retail customers can more easily attract manufacturers of successful products. Also, wholesalers that serve large markets may be more attractive since producers may be able to reduce the number of wholesalers they deal with and thereby lower their costs. Long-term profitable producer–wholesaler relationships are enhanced by trust, doing a good job for one another, and open communication about problems and opportunities. Wholesalers also need to attract retailers and organizational customers to buy from them. In many cases, wholesalers have exclusive contracts to distribute products in a particular trading area. For popular products and brands with large market shares, the wholesaler’s task is simplified because retailers want to carry them. For example, distributors of Coke and Pepsi can attract retailers easily because the products sell so well and consumers expect to find them in many retail outlets. Retail supermarkets and convenience stores would be at a competitive disadvantage without these brands. However, for new or small market-share products and brands, particularly those of less well-known manufacturers, wholesalers may have to do considerable marketing to get retailers to stock them. Wholesalers may get placement for such products and brands in retail stores because they have previously developed strong long-term working relationships with them. Alternatively, wholesalers may have to carefully explain the marketing plan for the product, why it should be successful, and why carrying the product will benefit the retailer. While there are still many successful wholesalers, the share of products they sell is likely to continue to decrease. This is because large retail chains such as Walmart have gained such market power that they can buy directly from manufacturers and bypass wholesalers altogether. The survival of wholesalers depends on their ability to meet the needs of both manufacturers and retailers by performing distribution functions more efficiently and effectively than a channel designed without them. STORE AND NONSTORE RETAILING As noted, retailers are merchants who are primarily engaged in selling to ultimate consumers. The more than 1.9 million retailers in the United States can be classified in many ways. For example, they are broken down in the North American Industry Classification System (NAICS) codes into eight general categories and a number of subcategories based on the types of merchandise they sell.5 Marketers have a number of decisions to make to determine the best way to retail their products. For example, decisions have to be made about whether to use stores to sell merchandise, and if so, whether to sell through company-owned stores, franchised outlets, or independent stores or chains. Decisions have to be made about whether to sell through MARKETING INSIGHT Some Benefits of Wholesalers for Various Channel Members 10–3 BENEFITS FOR MANUFACTURERS • Provide the ability to reach diverse geographic markets cost effectively. • Provide information about retailers and end users in various markets. • Reduce costs through greater efficiency and effectiveness in distribution functions performed. • Reduce potential losses by assuming risks and offering expertise. BENEFITS FOR RETAILERS • • • • Provide potentially profitable products otherwise unavailable for resale in retail area. Provide information about industries, manufacturers, and other retailers. Reduce costs by providing an assortment of goods from different manufacturers. Reduce costs through greater efficiency in distribution functions performed. BENEFITS FOR END USERS • Increase the product alternatives available in local markets. • Reduce retail prices by the efficiency and effectiveness contributed to the channel. • Improve product selection by providing information to retailers about the best products to offer end users. nonstore methods, such as the Internet, and if so, which methods of nonstore retailing should be used. Each of these decisions brings about a number of others such as what types of stores to use, how many of them, what locations should be selected, and what specific types of nonstore retailing to use. Store Retailing About 90 percent of retail purchases are made through stores. This makes them an appropriate retail method for most types of products and services. Retailers vary not only in the types of merchandise they carry but also in the breadth and depth of their product assortments and the amount of service they provide. In general, mass merchandisers carry broad product assortments and compete on two bases. Supermarkets (Kroger) and department stores (Macy’s) compete with other retailers on the basis of offering a good selection in a number of different categories, whereas supercenters (Walmart Supercenters), warehouse clubs (Costco), discount stores (Walmart), and off-price retailers (T.J. Maxx) compete more on the basis of offering lower prices on products in their large assortments. Manufacturers of many types of consumer goods must get distribution in one or more types of mass merchandisers to be successful. Specialty stores handle deep assortments in a limited number of product categories. Specialty stores include limited-line stores that offer a large assortment of a few related product lines (The Gap), single-line stores that emphasize a single product (Batteries Plus), and category killers (Best Buy), which are large, low-priced limited-line retail chains that attempt to dominate a particular product category. If a product type is sold primarily through specialty stores and sales are concentrated in category killer chains, manufacturers may have to sell through them to reach customers. Convenience stores (7-Eleven) are retailers whose primary advantages to consumers are location convenience, close-in parking, and easy entry and exit. They stock products that consumers want to buy in a hurry, such as milk or soft drinks, and charge higher prices for the purchase convenience. They are an important retail outlet for many types of convenience goods. 166 Chapter Ten Distribution Strategy 167 In selecting the types of stores and specific stores and chains to resell their products, manufacturers (and wholesalers) have a variety of factors to consider. They want stores and chains that reach their target market and have good reputations with consumers. They want stores and chains that handle distribution functions efficiently and effectively, order large quantities, pay invoices quickly, display their merchandise well, and allow them to make good profits. Selling products in the right stores and chains increases sales, and selling in prestigious stores can increase the equity of a brand and the price that can be charged. The locations of retail stores, the types of people who shop at them, and the professionalism of the salespeople and clerks who work in them all affect the success of the stores and the products they sell. In addition to the merchandise offered, store advertising, and price levels, the characteristics of the store itself—including layout, colors, smells, noises, lights, signs, and shelf space and displays—influence the success of both the stores and the products they offer. Nonstore Retailing Although stores dominate sales for most products, there are still opportunities to market products successfully in other ways. Five nonstore methods of retailing include catalogs and direct mail, vending machines, television home shopping, direct sales, and electronic exchanges.6 Catalogs and Direct Mail Catalogs and direct mail dominate nonstore retailing. The advantages of this type of nonstore retailing for marketers are that consumers can be targeted effectively and reached in their homes or at work, overhead costs are decreased, and assortments of specialty merchandise can be presented with attractive pictures and in-depth descriptions of features and benefits. Catalogs can also remain in homes or offices for a lengthy time period, making available potential sales. Catalogs can offer specialty products for unique markets that are geographically dispersed in a cost-effective manner. Although consumers cannot experience products directly as they can in stores, catalog retailers with reputations for quality and generous return policies can reduce consumers’ risks. For example, Levenger, which sells pens, desks, and “other tools for serious readers,” sends consumers a postage-paid label to return unwanted merchandise. Many consumers enjoy the time savings of catalog shopping and are willing to pay higher prices to use it. Vending Machines Vending machines are a relatively limited method of retail merchandising, and most vending machine sales are for beverages, food, and candy. The advantages for marketers include the following: They are available for sales 24 hours a day, they can be placed in a variety of high-traffic locations, and marketers can charge higher prices. While uses of vending machines for such things as airline insurance and concert and game tickets are not unusual, this method has limited potential for most products. Television Home Shopping Television home shopping includes cable channels dedicated to shopping, infomercials, and direct-response advertising shown on cable and broadcast networks. Home Shopping Network and QVC are the leaders in this market, and the major products sold are inexpensive jewelry, apparel, cosmetics, and exercise equipment. While this method allows better visual display than catalogs, potential customers must be watching at the time the merchandise is offered; if not, they have no way of knowing about the product or purchasing it. 168 Part C The Marketing Mix Direct Sales Direct sales are made by salespeople to consumers in their homes or offices or by telephone. The most common products purchased this way are cosmetics, fragrances, decorative accessories, vacuum cleaners, home appliances, cooking utensils, kitchenware, jewelry, food and nutritional products, and educational materials. Avon, Mary Kay, and Tupperware are probably the best-known retail users of this channel. Salespeople can demonstrate products effectively and provide detailed feature and benefit information. A limitation of this method is that consumers are often too busy to spend their time this way and do not want to pay the higher prices needed to cover the high costs of this method of retailing. Online and Mobile Retailing Online retailing is the marketing of products and services directly to consumers via the Internet. Some of the products and services are digital in that they are delivered directly to consumers’ computers, smartphones, and tablets. These include music and software downloads, information services, insurance and other financial services, e-books, computer games, and movie rentals, among others. Other products are tangible, such as clothing or computers, that require physical delivery to consumers. Online retailing is the fastest-growing type of retailing, and in some years, online sales have grown 20 to 25 percent. The percentage of total retail sales that are on the Internet is expected to grow to more than 12 percent in the near future. Some of the growth in online sales is the result of online-only stores like Amazon.com and Priceline.com developing successful strategies to serve consumers effectively. However, much of the growth has come about because established retailers have set up virtual stores as an additional channel to their brick-and-mortar stores. For example, Eddie Bauer, Lands’ End, Bass Pro Shops, and Cabela’s all offer products for sale in stores, in catalogs, and on the Internet. Figure 10.7 lists some of the advantages and disadvantages of online retailing for marketers. In examining this figure, it is important to recognize that there are some FIGURE 10.7 Online Retailing: Advantages and Disadvantages for Marketers Advantages for Marketers Reduces the need for stores, paper catalogs, and salespeople; can be cost efficient. Allows good visual presentation and full description of product features and benefits. Allows vast assortments of products to be offered efficiently. Allows strategic elements, such as product offerings, prices, and promotion appeals, to be changed quickly. Allows products to be offered globally in an efficient manner. Allows products to be offered 24 hours a day, 365 days a year. Fosters the development of one-on-one, interactive relationships with customers. Provides an efficient means for developing a customer database and doing online marketing research. Disadvantages for Marketers Strong price competition online often squeezes profit margins. Low entry barriers lead some e-marketers to overemphasize order-taking and not develop sufficient infrastructure for order fulfillment. Customers must go to the website rather than having marketers seek them out via salespeople and advertising; advertising their websites is prohibitively expensive for many small e-marketers. Limits the market to customers who are willing and able to purchase electronically; many countries still have a small population of computer-literate people. Not as good for selling touch-and-feel products as opposed to look-and-buy products unless there is strong brand/store/site equity (Dell computers/Walmart/Amazon.com) or the products are homogeneous (books, CDs, plane tickets, etc.). Often less effective and efficient in business-to-consumer markets than in business-to-business markets. MARKETING INSIGHT Questions to Ask When Developing Successful Commercial Websites 10–4 When developing commercial websites, it is important to consider what customers experience when searching for information, evaluating alternative products, and purchasing them. Here are some basic questions that website designers should consider. INFORMATION SEARCH 1. Ease of navigation—is it easy to move throughout the website? 2. Speed of page downloads—does each page load quickly enough? 3. Effectiveness of search features—are search features returning the information users are looking for? 4. Frequency of product updates—is product information updated often enough to meet user needs? EVALUATION OF ALTERNATIVES 1. Ease of product comparisons—is it easy to compare different products offered on the website? 2. Product descriptions—are product descriptions accurate, clear, and comprehensive enough to allow customers to make informed decisions? 3. Contacting customer service representatives—are customer service phone numbers easy to locate? 4. In-stock status—are out-of-stock products flagged before the customer proceeds to the checkout process? PURCHASE 1. Security and privacy issues—do users feel comfortable transmitting personal information? 2. Checkout process—are users able to move through the checkout process in a reasonable amount of time? 3. Payment options—are payment options offered that nonbuyers desire? 4. Delivery options—are delivery options offered that nonbuyers desire? 5. Ordering instructions—are ordering instructions easy to understand? Source: Based on K. Douglas Hoffman and John E. G. Bateson, Services Marketing: Concepts, Strategies, and Cases, 3rd ed. (Mason, OH: Thomson South-Western, 2006), p. 86. differences in advantages and disadvantages depending on whether the marketer is a small, entrepreneurial venture or a large, established company. Because online retailing offers low-entry barriers, this is an advantage for a small company that wants to get into a market and compete for business with less capital. However, for large, established companies, this is less of an advantage because they have the capital to invest: Lowentry barriers create more competition for them from smaller companies. Similarly, large companies with established names and brand equity can more easily market products that customers would ordinarily want to examine before purchase (touch-and-feel products) than can smaller companies with less brand equity. This does not mean that virtual-only companies cannot compete for business. Companies like Amazon.com and Priceline.com have created well-known and well-respected websites and have generated considerable sales and profits. One of the recent developments in online retailing is mobile retailing in which products and services are marketed to consumers via smartphones and tablets. Consumers can be standing in a retail store and search for information about products and competitive prices with their smartphone. Consumers can collect information in a brick-andmortar store and then order the product online using a tablet. Smartphones and tablets are commonly used to look for coupons, read product reviews, get product information, 169 and look for lower prices. 170 Part C The Marketing Mix Multichannel Marketing As noted, a number of companies offer products and services in stores, in catalogs, and online. This is called multichannel marketing, and it has been found that sales usually increase with this strategy over that of a single channel. However, there are some problems in implementing this strategy that marketers have not fully overcome. While it is easy to argue that all channels should provide a consistent marketing mix, some marketers have had difficulty generating such a mix. For example, some marketers have had difficulty in pricing because their in-store prices are too high to compete effectively in online retailing, where lower prices are the norm. Thus, they may have to offer the same product at a lower price online than in their stores in order to compete with sites like Amazon.com: Barnes & Noble does so, for example. Similarly, while marketers can provide abundant information and imagery on a full-screen computer, smartphones cannot easily handle such complexity. This, combined with concerns about transaction speed and security, may explain why relatively few purchases are actually made on smartphones, compared with tablets and desktop computers.7 Also, unique skills and resources are needed for different channels. For example, different types of managers, salespeople, distribution centers, and delivery systems are needed for store-based retail chains versus online retailing. While marketers are still working on these issues, one thing that can help provide consistency is a customer relationship management system. This involves a centralized customer data warehouse that houses a complete history of each customer’s interactions with the company—regardless of whether it occurred in a store, on the Internet, on the telephone, or by mail. Such an information storehouse allows marketers to efficiently handle complaints, expedite returns, target promotions, and provide a near-seamless experience for customers.8 SUMMARY This chapter introduced the distribution of goods and services in a complex, highly competitive, highly specialized economy. It emphasized the vital need for marketing intermediaries to bring about exchanges between buyers and sellers in a reasonably efficient manner. The chapter examined various types of intermediaries and the distribution functions they perform as well as topics in the selection and management of distribution channels. Finally, both wholesaling and store and nonstore retailing were discussed. Additional Resources Coughlin, Anne T., Erin Anderson, Louis W. Stern, and Adel I. El-Ansary. Marketing Channels. 7th ed. Upper Saddle River, NJ: Prentice Hall, 2006. Levy, Michael, and Barton A. Weitz. Retailing Management. 8th ed. Burr Ridge, IL: McGraw-Hill, 2012. Pasqua, Rachel, and Noah Elkin. Mobile Marketing. Indianapolis: John Wiley and Sons, 2013. Rosenbloom, Bert. Marketing Channels: A Management View. 8th ed. Mason, OH: Thomson South-Western, 2012. Simchi-Levi, David, Philip Kaminsky, and Edith Simchi-Levi. Designing and Managing the Supply Chain. 3rd ed. Burr Ridge, IL: McGraw-Hill, 2008. Key Terms and Concepts Note: For definitions of the major types of marketing intermediaries, see Figure 10.1 and for the major functions performed in channels of distribution, see Figure 10.2 at the beginning of this chapter. Administered system: A vertical marketing system with a higher degree of interorganizational planning than a conventional channel often brought about by having a strong channel leader. Chapter Ten Distribution Strategy 171 Backward integration: The purchase by wholesalers or retailers of channel members above them. Channel of distribution: The combination of institutions through which a seller markets products to organizational buyers or ultimate consumers. Contractual system: A vertical marketing system that involves independent production and distribution companies entering into formal contracts to perform designated marketing functions. Convenience stores: Retailers whose primary advantages to consumers are location convenience, close-in parking, and easy entry and exit. They typically stock a limited number of items that consumers want to buy in a hurry, such as milk or soft drinks and include stores like 7-Eleven and PDQ. Corporate system: A vertical marketing system involving single ownership of two or more levels of a channel such as a manufacturer owning a wholesale operation. Direct channels: Channels in which the manufacturer sells directly to a market without the use of intermediaries. Direct marketing: A direct channel in which the seller uses direct mail, telemarketing, directaction advertising, catalog selling, cable selling, online selling, or direct selling through demonstrations at home or place of work to reach buyers. Exclusive distribution: An approach to distribution that involves the manufacturer providing exclusive rights to intermediaries in particular territories. Forward integration: A manufacturer’s purchase of wholesalers or retailers who distribute its products. Indirect channels: Distribution channels with one or more intermediaries. Intensive distribution: An approach to distribution that involves using as many wholesalers and retailers as possible to get broad distribution. It is commonly used with convenience goods. Mass merchandisers: Large retailers that carry broad product assortments and compete on the basis of a good selection in a number of different categories (e.g., Macy’s, Kroger) or on the basis of lower prices on products in their large assortment (e.g., Walmart, Costco). Mobile retailing: The marketing of products and services directly to consumers via smartphones and tablets. Multichannel marketing: Offering products and services in multiple channels such as in stores, in catalogs, and online. Online retailing: The marketing of products and services directly to consumers via the Internet. Consumers can search, order, and pay for products on their computers, tablets, or smartphones using this channel. Relationship marketing: Marketing with the conscious aim to develop and manage long-term and/ or trusting relationships with customers, distributors, suppliers, or other parties in the marketing environment. Selective distribution: An approach to distribution in which the manufacturer limits the use of intermediaries to the best available in a geographic area. The intermediaries are commonly selected on the basis of the service or sales organization available or reputation. Specialty stores: Stores that handle deep assortments in a limited number of product categories, such as The Gap, Batteries Plus, or Best Buy. Total distribution costs: Concept that suggests that a channel of distribution should be viewed as a total system composed of interdependent subsystems and that the objective of the system (channel) manager should be to optimize total system performance. This typically means the total system should minimize costs for a given level of service. Vertical marketing systems: Channels in which members are more dependent on one another and develop long-term working relationships in order to improve the efficiency and effectiveness of the system. Chapter 11 Pricing Strategy One of the most important and complex decisions a firm has to make relates to pricing its products or services. If consumers or organizational buyers perceive a price to be too high, they may purchase competitive brands or substitute products, leading to a loss of sales and profits for the firm. If the price is too low, sales might increase, but profitability may suffer. Thus, pricing decisions must be given careful consideration when a firm is introducing a new product or planning a short- or long-term price change. This chapter discusses demand, supply, and environmental influences that affect pricing decisions and emphasizes that all three must be considered for effective pricing. However, as will be discussed in the chapter, many firms price their products without explicitly considering all of these influences. DEMAND INFLUENCES ON PRICING DECISIONS Demand influences on pricing decisions concern primarily the nature of the target market and expected reactions of consumers to a given price or change in price. There are three primary considerations here: demographic factors, psychological factors, and price elasticity. Demographic Factors In the initial selection of the target market that a firm intends to serve, a number of demographic factors are usually considered. Demographic factors that are particularly important for pricing decisions include the following: Part C The Marketing Mix 1. 2. 3. 4. 5. Number of potential buyers. Location of potential buyers. Position of potential buyers (organizational buyers or final consumers). Expected consumption rates of potential buyers. Economic strength of potential buyers. These factors help determine market potential and are useful for estimating expected sales at various price levels. Psychological Factors Psychological factors related to pricing concern primarily how consumers will perceive various prices or price changes. For example, marketing managers should be concerned with such questions as these: 1. Will potential buyers use price as an indicator of product quality? 2. Will potential buyers be favorably attracted by odd pricing (e.g., 99¢, $3,999)? 172 MARKETING INSIGHT Is the Price of a Product Only Money? 11–1 Most analyses of the price of a product focus on the amount of money a buyer must pay to purchase. However, there are other costs involved that can strongly influence purchase decisions. Here are three types of costs marketing analysts should consider when making pricing decisions. Time Costs. Time is valuable to most people. Time involved in purchasing products often could be used for more pleasant activities. Waiting in a long checkout line or waiting for a pizza to be delivered can be considered a waste of time too. Many people are willing to pay more money to reduce the time they have to wait to get a product. Vending machine sales often depend on buyers who will pay more money to get a product sooner and with less hassle. People who want a product immediately are often willing to finance the purchase on a credit card to reduce the time waiting to get it. Psychological Costs. The mental energy and stress in making important purchases and accepting the risks of products not performing as expected can make buyers uncomfortable. Purchasing complex or expensive products can involve investigating and evaluating lots of information and worrying about making the right choices. Car dealers that offer “no haggle” sales do so in order to lower buyers’ psychological costs of negotiating. Behavioral Costs. Buying products and services usually requires some level of physical activity. These costs can increase if buyers have to drive a long way to make a purchase, park far away in a large mall parking lot and have to walk to the store, hunt through many aisles looking for products, and stand for long periods waiting to check out. One way buyers reduce this cost is by shopping and buying from catalogs or the Internet even if they have to pay more money because of shipping charges. If buyers in a target market are sensitive to these costs, it is possible for marketers to get a competitive advantage by reducing them. These strategies include such things as selling through multiple channels, free shipping, fast delivery, in-store credit, no-hassle return policies, and money-back quarantees. Another strategy is to reduce the monetary price of products in order to compensate for higher time, psychological, or behavioral costs. For example, Walmart’s lower monetary prices help offset the additional costs to buyers of having to drive longer distances to get to the stores that are located on the outskirts of most markets. 3. Will potential buyers perceive the price as too high relative to the service the product gives them or relative to competition? 4. Are potential buyers prestige oriented and therefore willing to pay higher prices to fulfill this need? 5. How much will potential buyers be willing to pay for the product? While psychological factors have a significant effect on the success of a pricing strategy and ultimately on marketing strategy, answers to the preceding questions may require considerable marketing research. In fact, a review of buyers’ subjective perceptions of price concluded that very little is known about how price affects buyers’ perceptions of alternative purchase offers and how these perceptions affect purchase response.1 However, some tentative generalizations about how buyers perceive price have been formulated. For example, research has found that persons who choose high-priced items usually perceive large quality variations within product categories and see the consequences of a poor choice as being undesirable. They believe that quality is related to price and see themselves as good judges of product quality. In general, the reverse is true for persons who select low-priced items in the same product categories. Thus, although information on psychological factors involved in purchasing may be difficult to obtain, marketing managers must at least consider the effects of such factors on their desired target market and marketing strategy.2 173 174 Part C The Marketing Mix There are three types of psychological pricing strategies. First there is prestige pricing, in which a high price is charged to create a signal that the product is exceptionally fine. Prestige pricing is commonly used for some brands of cars, clothing, perfume, jewelry, cosmetics, wine and liquor, and crystal and china. Second, there is odd pricing, or odd-even pricing, in which prices are set a few dollars or a few cents below a round number. For example, FritoLay’s potato chips are priced at 69 cents a bag rather than 70 cents to encourage consumers to think of them as less expensive (60 some-odd cents rather than 70 cents). Hertz economy cars are rented for $129 rather than $130 to appear less expensive. Third, there is bundle pricing, in which several products are sold together at a single price to suggest a good value. For example, travel agencies offer vacation packages that include travel, accommodations, and entertainment at a single price to connote value and convenience for customers. Price Elasticity Both demographic and psychological factors affect price elasticity. Price elasticity is a measure of consumers’ price sensitivity, which is estimated by dividing relative changes in the quantity sold by the relative changes in price: Percent change in quantity demanded e 5 }}}} Percent change in price Although price elasticity is difficult to measure, two basic methods are commonly used to estimate it. First, price elasticity can be estimated from historical data or from price/ quantity data across different sales districts. Second, price elasticity can be estimated by sampling a group of consumers from the target market and polling them concerning various price/quantity relationships. Both of these approaches provide estimates of price elasticity; but the former approach is limited to the consideration of price changes, whereas the latter is often expensive and there is some question as to the validity of subjects’ responses. However, even a crude estimate of price elasticity is a useful input to pricing decisions.3 SUPPLY INFLUENCES ON PRICING DECISIONS For the purpose of this text, supply influences on pricing decisions can be discussed in terms of three basic factors. These factors relate to the objectives, costs, and nature of the product. Pricing Objectives Pricing objectives should be derived from overall marketing objectives, which in turn should be derived from corporate objectives. Since it is traditionally assumed that business firms operate to maximize profits in the long run, it is often thought that the basic pricing objective is solely concerned with long-run profits. However, the profit maximization norm does not provide the operating marketing manager with a single, unequivocal guideline for selecting prices. In addition, the marketing manager does not have perfect cost, revenue, and market information to be able to evaluate whether or not this objective is being reached. In practice, then, many other objectives are employed as guidelines for pricing decisions. In some cases, these objectives may be considered as operational approaches to achieve long-run profit maximization. Research has found that the most common pricing objectives are (1) pricing to achieve a target return on investment, (2) stabilization of price and margin, (3) pricing to achieve a target market share, and (4) pricing to meet or prevent competition. Cost Considerations in Pricing The price of a product usually must cover costs of production, promotion, and distribution, plus a profit, for the offering to be of value to the firm. In addition, when products are MARKETING INSIGHT Retail Pricing Strategies: EDLP or High/Low? 11–2 There are two common pricing strategies at the retail level: EDLP, which stands for “everyday low pricing,” and high/low, which means that the retailer charges prices that are sometimes above competitors’ but promotes frequent sales that lower prices below them. Four successful U.S. retailers—Home Depot, Walmart, Office Depot, and Toys ‘R’ Us—have adopted EDLP, while many fashion, grocery, and drug stores use high/low. The following is a list of the advantages of each of these pricing strategies. ADVANTAGES OF EDLP • Assures customers of low prices. Many customers are skeptical about initial retail prices. They have become conditioned to buying only on sale—the main characteristic of a high/low pricing strategy. The EDLP strategy lets customers know that they will get the same low prices every time they patronize the EDLP retailer. Customers do not have to read the ads and wait for items they want to go on sale. • Reduces advertising and operating expenses. The stable prices caused by EDLP limit the need for the weekly sale advertising used in the high/low strategy. In addition, EDLP retailers do not have to incur the labor costs of changing price tags and signs and putting up sale signs. • Reduces stockouts and improves inventory management. The EDLP approach reduces the large variations in demand caused by frequent sales with large markdowns. As a result, retailers can manage their inventories with more certainty. Fewer stockouts mean more satisfied customers, resulting in higher sales. In addition, a more predictable customer demand pattern enables the retailer to improve inventory turnover by reducing the average inventory needed for special promotions and backup stock. ADVANTAGES OF HIGH/LOW • Increases profits. High/low pricing allows retailers to charge higher prices to customers who are not price-sensitive and will pay the “high” price and to charge lower prices to price-sensitive customers who will wait for the “low” sale price. • Creates excitement. A “get them while they last” atmosphere often occurs during a sale. Sales draw a lot of customers, and a lot of customers create excitement. Some retailers augment low prices and advertising with special in-store activities, such as product demonstrations, giveaways, and celebrity appearances. • Sells merchandise. Sales allow retailers to get rid of slow-selling merchandise. Source: Based on Michael Levy and Barton A. Weitz, Retailing Management, 8th ed. (Burr Ridge, IL: McGraw-Hill/Irwin, 2012), p. 373. priced on the basis of costs plus a fair profit, there is an implicit assumption that this sum represents the economic value of the product in the marketplace. Cost-oriented pricing is the most common approach in practice, and there are at least three basic variations: markup pricing, cost-plus pricing, and rate-of-return pricing. Markup pricing is commonly used in retailing: A percentage is added to the retailer’s invoice price to determine the final selling price. Closely related to markup pricing is costplus pricing, in which the costs of producing a product or completing a project are totaled and a profit amount or percentage is added on. Cost-plus pricing is most often used to describe the pricing of jobs that are nonroutine and difficult to “cost” in advance, such as construction and military weapon development. Rate-of-return pricing is commonly used by manufacturers. With this method, price is determined by adding a desired rate of return on investment to total costs. Generally, a breakeven analysis is performed for expected production and sales levels and a rate of return is added on. For example, suppose a firm estimated production and sales to be 75,000 units at a total cost of $300,000. If the firm desired a before-tax return of 20 percent, the selling price would be (300,000 1 0.20 3 300,000) 4 75,000 5 $4.80. 175 MARKETING INSIGHT Basic Breakeven Formulas 11–3 The following formulas are used to calculate breakeven points in units and in dollars: FC BEP(in units) 5 }} (SP 2 VC ) FC BEP(in dollars) 5 }} 1 2 (VCySP) where FC 5 Fixed cost VC 5 Variable cost SP 5 Selling price If, as is generally the case, a firm wants to know how many units or sales dollars are necessary to generate a given amount of profit, profit (P) is simply added to fixed costs in the formulas. In addition, if the firm has estimates of expected sales and fixed and variable costs, the selling price can be solved for. (A more detailed discussion of breakeven analysis is provided in the financial analysis section of this book.) Cost-oriented approaches to pricing have the advantage of simplicity, and many practitioners believe that they generally yield a good price decision. However, such approaches have been criticized for two basic reasons. First, cost approaches give little or no consideration to demand factors. For example, the price determined by markup or cost-plus methods has no necessary relationship to what people will be willing to pay for the product. In the case of rate-of-return pricing, little emphasis is placed on estimating sales volume. Even if it were, rate-of-return pricing involves circular reasoning, since unit cost depends on sales volume but sales volume depends on selling price. Second, cost approaches fail to reflect competition adequately. Only in industries where all firms use this approach and have similar costs and markups can this approach yield similar prices and minimize price competition. Thus, in many industries, cost-oriented pricing could lead to severe price competition, which could eliminate smaller firms. Therefore, although costs are a highly important consideration in price decisions, numerous other factors need to be examined. Product Considerations in Pricing Although numerous product characteristics can affect pricing, three of the most important are (1) perishability, (2) distinctiveness, and (3) stage in the product life cycle. Perishability Some products, such as fresh meat, bakery goods, and some raw materials are physically perishable and must be priced to sell before they spoil. Typically, this involves discounting the products as they approach being no longer fit for sale. Products can also be perishable in the sense that demand for them is confined to a specific time period. For example, high fashion and fad products lose most of their value when they go out of style and marketers have the difficult task of forecasting demand at specific prices and judging the time period of customer interest. While the time period of interest for other seasonal products, such as winter coats or Christmas trees, is easier to estimate, marketers must still determine the appropriate price and discount structure to maximize profits and avoid inventory losses or carrying costs. Distinctiveness 176 Marketers try to distinguish their products from those of competitors and if successful, can often charge higher prices for them. While such things as styling, features, ingredients, and service can be used to try to make a product distinctive, competitors can copy such physical Chapter Eleven Pricing Strategy 177 changes. Thus, it is through branding and brand equity that products are commonly made distinctive in customers’ minds. For example, prestigious brands like Rolex, Tiffany’s, and Lexus can be priced higher in large measure because of brand equity. Of course, higher prices also help create and reinforce the brand equity of prestigious products. Life Cycle The stage of the life cycle that a product is in can have important pricing implications. With regard to the life cycle, two approaches to pricing are skimming and penetration price policies. A skimming policy is one in which the seller charges a relatively high price on a new product. Generally, this policy is used when the firm has a temporary monopoly and when demand for the product is price inelastic. In later stages of the life cycle, as competition moves in and other market factors change, the price may then be lowered. Flat screen TV’s and cell phones are examples of this. A penetration policy is one in which the seller charges a relatively low price on a new product. Generally, this policy is used when the firm expects competition to move in rapidly and when demand for the product is, at least in the short run, price elastic. This policy is also used to obtain large economies of scale and as a major instrument for rapid creation of a mass market. A low price and profit margin may also discourage competition. In later stages of the life cycle, the price may have to be altered to meet changes in the market. ENVIRONMENTAL INFLUENCES ON PRICING DECISIONS Environmental influences on pricing include variables that the marketing manager cannot control. Three of the most important of these are the Internet, competition and government regulation. The Internet One of the biggest influences on pricing decisions has been the development of the Internet. Prior to its development, it was difficult for consumers to compare prices effectively. Consumers would have to travel from store to store or call each store and try to find identical brands and models to compare prices. For many products, like televisions and appliances, this was difficult to do because competitors seldom carried the same brands and models. However, consumers now can simply go from store to store online and compare prices, or go to websites that do price comparisons for them and find the best deals (e.g., kayak.com and expedia.com). Consumers can go to Google, put in the product and brand they are looking for, hit the Shopping tab, and let the web browser find it for them at a variety of sites and prices. Consumers can go to Edmunds.com and find out how much a dealer has paid for an automobile or truck as well as how much customers in their area have been paying for a particular model. In sum, the Internet has made prices much easier for consumers and organizational buyers to compare and has forced marketers to be much more transparent in their pricing strategies. Competition In setting or changing prices, the firm must consider its competition and how competition will react to the price of the product. Initially, consideration must be given to such factors as 1. 2. 3. 4. Number of competitors. Market shares, growth, and profitability of competitors. Strengths and weaknesses of competitors. Likely entry of new firms into the industry. 178 Part C The Marketing Mix 5. 6. 7. 8. Degree of vertical integration of competitors. Number of products sold by competitors. Cost structure of competitors. Historical reaction of competitors to price changes. These factors help determine whether the firm’s selling price should be at, below, or above competition. Pricing a product at competition (i.e., the average price charged by the industry) is called going-rate pricing and is popular for homogeneous products, since this approach represents the collective wisdom of the industry and is not disruptive of industry harmony. An example of pricing below competition can be found in sealed-bid pricing, in which the firm is bidding directly against competition for project contracts. Although cost and profits are initially calculated, the firm attempts to bid below competitors to obtain the job contract. A firm may price above competition because it has a superior product or because the firm is the price leader in the industry. Government Regulations Prices of certain goods and services are regulated by state and federal governments. Public utilities are examples of state regulation of prices. However, for most marketing managers, federal laws that make certain pricing practices illegal are of primary consideration in pricing decisions. The following list is a summary of some of the more important legal constraints on pricing. Of course, since most marketing managers are not trained as lawyers, they usually seek legal counsel when developing pricing strategies to ensure conformity to state and federal legislation. 1. Price fixing is illegal per se. Sellers must not make any agreements with competitors or distributors concerning the final price of the goods. The Sherman Antitrust Act is the primary device used to outlaw horizontal price fixing. Section 5 of the Federal Trade Commission Act has been used to outlaw price fixing as an unfair business practice. 2. Deceptive pricing practices are outlawed under Section 5 of the Federal Trade Commission Act. An example of deceptive pricing would be to mark merchandise with an exceptionally high price and then claim that the lower selling price actually used represents a legitimate price reduction. 3. Price discrimination (the practice of charging different prices to different buyers for goods of like grade and quality) that lessens competition or is deemed injurious to it is outlawed by the Robinson-Patman Act. Price discrimination is not illegal per se, but sellers cannot charge competing buyers different prices for essentially the same products if the effect of such sales is injurious to competition. Price differentials can be legally justified on certain grounds, especially if the price differences reflect cost differences. This is particularly true of quantity discounts. 4. Predatory pricing involves charging a very low price for a product with the intent of driving competitors out of business. It is illegal under the Sherman Act and Federal Trade Commission Act.4 A GENERAL PRICING MODEL It should be clear that effective pricing decisions involve considerations of many factors, and different industries may have different pricing practices. Although no single model will fit all pricing decisions, Figure 11.1 presents a general model for developing prices for products and services.5 While all pricing decisions cannot be made strictly on the basis of this model, it does break pricing strategy into a set of manageable stages that are integrated into the overall marketing strategy. Chapter Eleven Pricing Strategy 179 FIGURE 11.1 A General Pricing Model Set pricing objectives Evaluate product–price relationships Estimate costs and other price limitations Analyze profit potential Set initial price structure Change price as needed Set Pricing Objectives Given a product or service designed for a specific target market, the pricing process begins with a clear statement of the pricing objectives. These objectives guide the pricing strategy and should be designed to support the overall marketing strategy. Because pricing strategy has a direct bearing on demand for a product and the profit obtained, efforts to set prices must be coordinated with other functional areas. For example, production will have to be able to meet demand at a given price, and finance will have to manage funds flowing in and out of the organization at predicted levels of production. Evaluate Product–Price Relationships As noted, the distinctiveness, perishability, and stage of the life cycle a product is in all affect pricing. In addition, marketers need to consider what value the product has for customers and how price will influence product positioning. There are three basic value MARKETING INSIGHT Ten Tips for Managing Pricing Strategy 11–4 1. The more that competitors and customers know about your pricing, the better off you are. In an information age, it is necessary to be transparent about prices and the value of a firm’s offerings. 2. In highly competitive markets, the focus should be on those market segments that provide opportunities to gain competitive advantage. Such a focus leads to a valueoriented pricing approach. 3. Pricing decisions should be made within the context of an overall marketing strategy that is embedded within a business or corporate strategy. 4. Successful pricing decisions are profit oriented, not sales volume or market share oriented. 5. Prices should be set according to customers’ perceptions of value. 6. Pricing for new products should start as soon as product development begins. 7. The relevant costs for pricing are the incremental avoidable, costs. 8. A price may be profitable when it provides for incremental revenues in excess of incremental costs. 9. A central organizing unit should administer the pricing function. Generally, it is better to avoid letting salespeople set price, especially without access to profitability information and specific training in pricing and revenue management. 10. Pricing management should be viewed as a process and price setting as a daily management activity, not a once-a-year activity. Source: From David Cravens and Nigel Piercy, Strategic Marketing 10E, 2013, p. 342. Reprinted with permission of McGraw-Hill Education. positions. First, a product could be priced relatively high for a product class because it offers value in the form of high quality, special features, or prestige. Second, a product could be priced at about average for the product class because it offers value in the form of good quality for a reasonable price. Third, a product could be priced relatively low for a product class because it offers value in the form of acceptable quality at a low price. A Porsche or Nike Air Max are examples of the first type of value; a Honda Accord or Keds tennis shoes are examples of the second; and Hyundai cars and private label canvas shoes are examples of the third. Setting prices so that targeted customers will perceive products to offer greater value than competitive offerings is called value pricing. In addition, research is needed to estimate how much of a particular product the target market will purchase at various price levels—price elasticity. This estimate provides valuable information about what the target market thinks about the product and what it is worth to them. Estimate Costs and Other Price Limitations The costs to produce and market products provide a lower bound for pricing decisions and a baseline from which to compute profit potential. If a product cannot be produced and marketed at a price to cover its costs and provide reasonable profits in the long run, then it should not be produced in its designed form. One possibility is to redesign the product so that its costs are lower. In fact, some companies first determine the price customers are willing to pay for a product and then design it so that it can be produced and marketed at a cost that allows targeted profits. Other price limitations that need to be considered are government regulations and the prices that competitors charge for similar and substitute products. Also, likely competitive 180 Chapter Eleven Pricing Strategy 181 reactions that could influence the price of a new product or a price change in an existing one need to be considered. Analyze Profit Potential Analysis in the preceding stages should result in a range of prices that could be charged. Marketers must then estimate the likely profit in pricing at levels in this range. At this stage, it is important to recognize that it may be necessary to offer channel members quantity discounts, promotional allowances, and slotting allowances to encourage them to actively market the product. Quantity discounts are discounts for purchasing a large number of units. Promotional allowances are often in the form of price reductions in exchange for the channel member performing various promotional activities, such as featuring the product in store advertising or on in-store displays. Slotting allowances are payments to retailers to get them to stock items on their shelves. All of these can increase sales but also add marketing cost to the manufacturer and affect profits. Set Initial Price Structure Since all of the supply, demand, and environmental factors have been considered, a marketer can now set the initial price structure. The price structure takes into account the price to various channel members, such as wholesalers and retailers, as well as the recommended price to final consumers or organizational buyers. Change Price as Needed There are many reasons why an initial price structure may need to be changed. Channel members may bargain for greater margins, competitors may lower their prices, or costs may increase with inflation. In the short term, discounts and allowances may have to be larger or more frequent than planned to get greater marketing effort to increase demand to profitable levels. In the long term, price structures tend to increase for most products as production and marketing costs increase. SUMMARY Pricing decisions that integrate the firm’s costs with marketing strategy, business conditions, competition, demand, product variables, channels of distribution, and general resources can determine the success or failure of a business. This places a very heavy burden on the price maker. Modern-day marketing managers cannot ignore the complexity or the importance of price management. Pricing strategies must be continually reviewed and must take into account that the firm is a dynamic entity operating in a very competitive environment. There are many ways for money to flow out of a firm in the form of costs, but often there is only one way to bring in revenues and that is by the price–product mechanism. Additional Resources Macdivitt, Harry, and Mike Wilkinson. Value-Based Pricing. New York: McGraw-Hill, 2012. Mazumdar, Tridib, S. P. Raj, and Indrajit Sinha. “Reference Price Research: Review and Propositions.” Journal of Marketing, October 2005, pp. 84–102. Monroe, Kent B. Pricing: Making Profitable Decisions. 3rd ed. New York: McGraw-Hill, 2003. Nagle, Thomas T., John Hogan, and Joseph Zale. The Strategy and Tactics of Pricing. 5th ed. Englewood Cliffs, NJ: Prentice Hall, 2011. Smith, Tim. Pricing Strategy. Mason, OH: Thomson South-Western, 2012. Winer, Russell S. Pricing. Cambridge, MA: Marketing Science Institute, 2005. 182 Part C The Marketing Mix Key Terms and Concepts Bundle pricing: A form of psychological pricing that involves selling several products together at a single price in order to suggest a good value. Cost-plus pricing: A cost-oriented pricing approach that involves totaling up the costs of producing a product or completing a project and then adding on a percentage or fixed profit amount. This approach is used when costs are difficult to estimate in advance such as military weapon development. Deceptive pricing: Illegal under the Federal Trade Commission Act, an approach that involves price deals that mislead the consumer. For example, putting a fake price on a product much higher than the product sells for in the market, crossing it out, and then offering the product at the market price and claiming a price reduction could easily mislead consumers. Going-rate pricing: Pricing a product at the average charged in the industry. Markup pricing: A cost-oriented pricing approach that involves adding a percentage to the invoice price in order to determine the final selling price . For example, if a retailer used a 50 percent markup on a product that was bought from a wholesaler for $1, the selling price to the consumer would be $1.50. Odd pricing: Also called odd-even pricing, a form of psychological pricing in which the prices are set at one or a few cents or dollars below a round number in order to create the perception that the price is low, for example, 99 cents or $129 rather than $1 or $130. Penetration pricing policy: Approach to pricing in which the seller charges a relatively low price on a new product initially in order to grow a market, gain market share, and discourage competition from entering the market. Prestige pricing: A form of psychological pricing that involves charging a high price to create a signal that the product is exceptionally fine. Predatory pricing: Practice that involves charging a very low price for a product with the intent of driving competitors out of business. It is illegal under the Sherman Act and Federal Trade Commission Act. Price discrimination: The practice of charging different prices to different buyers for goods of like grade and quality which is illegal under the Robinson-Patman Act if it lessens or is deemed injurious to competition. Price elasticity: A measure of consumers’ price sensitivity that is estimated by dividing relative changes in the quantity sold by relative changes in price. If demand is elastic, a slight lowering of price will result in a relatively large increase in quantity demanded. Price fixing: An unfair business practice outlawed by the Sherman Antitrust Act and the Federal Trade Commission Act that involves competitors in a market colluding to set the final price of a product. Promotional allowance: Price reduction offered to channel members in exchange for performing various promotional activities such as featuring the product in store advertising or on in-store displays. Quantity discounts: Discounts offered for purchasing a large number of units. Rate-of-return pricing: Cost-oriented approach to pricing that involves adding a desired rate of return on investment to total costs. Generally, a breakeven analysis is performed for expected production and sales levels and a rate of return is added on. Sealed-bid pricing: Bidding process in which each seller submits a sealed bid and attempts to price below competition in order to get the contract. Many large construction and military projects are bid this way. Skimming pricing policy: Approach to pricing in which the seller charges a relatively high price on a new product initially in order to recover costs and make profits rapidly and then lowers the price at a later date to make sales to more price-sensitive buyers. Slotting allowances: Payments to retailers to get them to stock items on their shelves, a common tactic for getting new products into stores. Value pricing: Setting prices so that targeted customers will perceive products to offer greater value than competitive offerings. For existing products, this can be accomplished by offering more product or service while maintaining or decreasing the dollar price.
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Marketing Management
Institutional Affiliation:


Chapter 10 introduces various concepts concerning distribution strategies in a highly
competitive and specialized economy. The chapter emphasized the need for marketing
intermediaries to facilitate efficient exchange between buyers and sellers. The channel of
distribution is used to refer to many institutions utilized by sellers to market goods and
services to consumers or organizational buyers. According to Peter and Donnelly (2014),
direct channels are used by manufacturers to distribute products to consumers without using
intermediaries. In this direct channel, the concept of direct marketing is used to refer to the
methods that sellers use to facilitate contact with consume...

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