Pizza Pricing Strategies
This week you learned about the three core pricing strategies: penetration, neutral, and skim.
Now we’re going to examine those pricing strategies in action. Hope you’re hungry, because
you’re going to be looking at a lot of pizza.
In this interactivity, you're going to briefly recap the three pricing strategies, use them to classify
the major pizza chains based on exploring the online ordering process and then answer a few
related questions. So let's dig in!
•
•
•
•
•
Chain #1: Pizza Hut- https://www.pizzahut.com/
Chain #2: Dominos- https://www.dominos.com/en/
Chain #3: Little Caesars- https://littlecaesars.com/en-us/
Chain #4: Papa Johns- https://www.papajohns.com/
Chain #5: California Pizza Kitchen- https://www.cpk.com/
Guided Response:
•
•
•
Re-familiarize yourself with the three main pricing strategies
o Review section 5.2 in the text as needed.
Research actual pizza pricing
o Visit each site, identify your location and simulate an order.
o Price out a medium cheese or pepperoni pizza.
o Proceed to payment stage, observing the selling process.
o Record your pizza choice and final price (minus tax).
o Execute your purchase as you see fit.
Create a forum post that includes the following:
o A brief description of the three pricing strategies (from least to most expensive).
o Your research driven price strategy classifications of the five brands.
▪ For any pricing strategy where you have multiple brands, rank them from
least to most expensive.
▪ Include the kind of pizza you priced out, your recorded prices and any
other pertinent notes.
▪ Your classifications may differ from others. That’s okay.
o Your answers to the following questions:
▪ Did your perception of these chains' pricing strategies change based on
this exercise? If so, how?
▪ Based on this exercise, identify three factors that complicate price
comparisons.
▪ For you, which of these chains represents the greatest value and why?
Explain how each of the Ps contributes to your answer.
5
Frans Lemmens/SuperStock
The Marketing Mix: Price
Learning Objectives
After studying this chapter, you should be able to:
• Give examples of how buyer psychology influences pricing strategy.
• Explain why a segmented price strategy is worth considering, despite its
complexity.
• Describe four inputs to the strategic planning process for pricing decisions.
• Explain the three objectives of sales promotions.
• Summarize three challenges to developing effective pricing strategies.
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Introduction
“P
rice” is a quantifiable way of measuring the value customers place on an offering. Marketers must understand the relationship of price to value, as value
reflects—and affects—the brand image of the offering and the company selling
it. This chapter presents concepts related to price, including how promotional enhancements affect potential customers’ perception of value.
Price plays two important roles in the marketing mix—it influences how much of an offering will sell and how much profit the sale will generate for the seller. There’s no point in
pricing an offering so low that, as the old joke goes, “we lose money on every sale but
make it up on the volume.” On the other hand, there’s no point in pricing an offering so
high that no one will buy.
Between those two boundaries lies every company’s pricing strategy.
5.1 Pricing Basics
W
hat is a price, exactly? The American Marketing Association defines price as “the
formal ratio that indicates the quantities of money, goods, or services needed to
acquire a given quantity of goods or services” (2011). At its simplest, price might
be described as what a customer has to give up in order to get what he wants to buy. That
customer’s sacrifice might consist of money, time, and/or effort.
Developing a pricing strategy is a requirement for every single business that brings an
offering to market. (A note about terms: offering is used throughout this chapter when the
unit for sale may be either a product or service. Since most of the principles of pricing
apply equally to goods and services, the use of offering prevents unnecessary wordiness.)
Failure to price appropriately can rob a business of its competitive edge or starve it by failing to generate sufficient revenue to cover costs. The fact that pricing strategy is complex
is reflected in the many terms used for “price.”
Contemplate the number of ways we refer to prices by matching the terms in Table 5.1
with the offering they purchase.
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Table 5.1: Many ways to say “price”
Offerings
Terms
Sandwich
Rent
Credit card
Price
Lawyer
Interest
Service club
Fee
Bus trip
Fare
Apartment
Dues
Instructions: Match the terms in Table 5.1 with the offering they purchase.
Why so many names for essentially the same thing—money
exchanged for ownership or use?
Because purchase exchanges
happen in so many aspects of
our culture.
In many cases a price is accompanied by adjustments that raise
or lower it—incentives, allowances, and/or extra fees. The
amount a buyer will actually
pay for an offering is seldom
represented simply by the price
listed for it.
Online education is a high‑demand product because it’s
Consider tuition for education convenient and relatively low cost. However, the price is elastic,
(yet another name for a price). meaning that if the cost increased, students might consider an
A school publishes its tuition alternative.
structure. The institution may
Serge Kozak/Corbis
offer scholarships and other
financial aid that reduces that
price. It may charge special
activity fees that raise that price. It may charge interest to students who opt to pay over
time. All those factors affect the price of a semester’s coursework.
If you chose to pursue your education online, you participated as a buyer in the exchange
of a quantity of money (tuition) to acquire a given quantity of services (education) from
the seller, to paraphrase our definition of price. Interest in distance learning is booming
as more people understand the cost savings and the convenience of taking a course from
anywhere, and more people have the equipment and online skills to take advantage of
those benefits.
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Table 5.2: Many ways to say “price” answers
Offerings
Terms
Sandwich
Price
Credit card
Interest
Lawyer
Fee
Service club
Dues
Bus trip
Fare
Apartment
Rent
“Price” goes by many names in daily life.
Price and the Marketing Mix
The marketing mix, as you have learned in previous chapters, consists of the four p’s of
Product, Place, Price, and Promotion. Price can be led or driven by the other four p’s of
the marketing mix but cannot be divorced from them. Which of the four will lead development of the marketing mix depends on the particulars of a company’s situation, target
market, and objectives.
As you learned in Chapter 1,
the Customer Value Equation
(the relationship between perceived benefits and the sacrifice
required to get those benefits)
is dynamic. As perceived benefits increase, value increases;
so does the customer’s estimation of a fair price for those benefits. This illustrates how a pricing strategy interacts with other
aspects of the marketing mix.
Factors affecting the price a
company charges for its offerings include customer expecThe brand image a company selects affects the price of its
tations, competitors’ pricing
merchandise since price reinforces brand identity. A luxury
strategies, and the brand image
offering cannot be bargain-priced and still maintain its high-end
a company has chosen to projpositioning.
ect, since price reinforces brand
Weng lei—Imaginechina/Associated Press identity. A luxury offering cannot be priced below a certain
amount and maintain its luxury aura, nor can a bargain offering be priced above a certain point and still maintain its value positioning. Similarly, customer expectations and
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competitors’ prices determine a range outside of which a price fails to be perceived as a
good value.
Customers’ Expectations and Pricing Strategy
Consumers must assess the value they’ll place on an offering, which means estimating
what service it will render. Does it fill a basic need or something less urgent? This is the
realm of psychology, where motivation, belief, and perception come into play. Let’s look
at how the psychological factors influencing buyers’ purchase behavior shapes sellers’
pricing decisions.
The entire purchase situation affects consumers’ perception of value. How products are
displayed, what items are nearby for comparison, how helpful the sales staff is, how
attractive the store seems—all of these affect consumer perception and, thus, expectations
about prices. Moreover, consumers are prone to perceive the situation inaccurately and to
react to their inaccurate evaluation of the situation. Fortunately, the psychology of price
perception and assignment of value has been well-researched (Nagle & Holden, 1995).
What does that research tell us?
First, marketers should be aware of reference pricing—the concept that consumers hold
reference points in mind regarding the expected price of many offerings. Whether remembered, researched, or inferred from the buying situation, the reference price represents “a
fair price” in the consumer’s mind. The reference price is often a price range, the endpoints
of which bracket the price points within which the price perceived as fair will fall. The
width of that price range held in the consumer’s mind affects his or her judgment of the
attractiveness of a posted price. Changes in context around the offering for sale can bring
about changes in the price range evoked in consumers’ minds and thus change perceptions of the attractiveness of a specific price (Janiszewski & Lichtenstein, 1999).
Customers typically know the prices of items they buy frequently. Their reference price
ranges on those items act as signposts that signal a store’s prices in general (Anderson &
Simester, 2003). If a store charges more than expected for Coca-Cola, for example, a consumer is likely to assume that all items in the store are more expensive than they should
be. Most people lack the time and inclination to research stores and compare brands to be
sure they are getting the best deal. Perceptual cues such as sale signs and prices ending
in 9 are surprisingly effective in influencing consumers’ beliefs about prices. Reference
pricing, signposts, and perceptual cues are all factors in consumers’ assessment of price
and value.
Other factors that influence perceptions of price include promotions, such as “buy one, get
one free” offers that invoke mental math leading to a favorable assessment of the posted
price, and marketing that links a specific purchase with a social cause or issue.
Finally, marketers must recognize potential buyers’ resistance to change. When a purchase will require buyers to spend on additional goods or services to gain its full value,
they hesitate. This spending, termed switching costs, can take several forms: Opportunity,
implementation, and conversion can each carry costs not included in the offering’s price,
but placing a burden on the buyer. For example, switching software in an office might
require spending on employee training or conversion of existing template documents. A
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member of an airline’s frequent flyer program considering a switch to another will have to
weigh the opportunity cost involved: Invariably the new program will bring some additional benefits, but the flyer will have to surrender perks of his or her previous program.
Companies can respond to, but not change, how consumers’ minds work. Buyer psychology must be taken into account as marketers develop a strategic marketing mix. Pricing
decisions will reflect this.
Field Trip 5.1: Reference Pricing and the Cloud
As cloud computing became a popular strategy for consumers to share and store digital assets like
photos and music, cloud storage services had to answer the question: What should storage cost? What
is the price range consumers will be willing to pay? Competition has created what Business Insider
called “A Race to Zero.” Read about it here:
This One Chart Shows the Vicious Price War Going on in Cloud Computing
http://www.businessinsider.com/cloud-computing-price-war-in-one-chart-2015-1
Follow this link to a tool that will let you compare providers’ services and prices.
https://www.cloudorado.com
Elasticity of Demand
As profound an impact on pricing as customers’ expectations is the concept economists
refer to as the Law of Supply and Demand. This economic principle states that, “all other
factors remaining equal, the higher the price of a good, the less people will demand that
good” (Investopedia.com, 2011).
Supply and demand represent the amount of a product sellers make available (supply)
and the amount buyers want to purchase (demand). When supply exceeds demand, buyers have greater control over the price suppliers can charge for an offering. When demand
exceeds supply, sellers have greater control over pricing.
Supply and demand curves represent this concept visually. The demand curve almost
always slopes downward as price decreases and quantity increases, because consumers
will typically buy more of the offering as its price goes down. The supply curve slopes
upward as the price increases, because consumers will buy less as the price goes up. This
model rests on assumptions that the marketplace follows a perfect competitive model in
which no firm has influence over the market price, and that a sufficient supply of buyers
and sellers exist with adequate information about product qualities and availability. In
this model, the point at which buyer and seller equilibrium meet is their shared equilibrium point, as shown in Figure 5.1. At this position, the price of an offering generates an
equal amount of demand and supply for that offering.
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Figure 5.1: Supply and demand curves
Price
Demand curve
Supply curve
Equilibrium price
Equilibrium quantity
Quantity
Supply and demand can achieve a point of equilibrium.
Source: Copyright © 2007, 2000, 1997, 1987, by Barron’s Educational Series, Inc. Reprinted by arrangement with Publisher.
Of course, there are many determinants of demand, such as individual tastes and the
existence (and price) of substitutes, in addition to the price of an offering. Even so, the
model provides a good enough approximation of marketplace behavior that predictions
based on the model are useful—one reason it is considered fundamental to pricing strategy (Schenk, 2011).
Let’s apply supply and demand curves to higher education: The lower the tuition (price)
for campus-based courses, the higher the quantity of those courses students will sign up
for. The higher the tuition for those classes, the smaller the quantity those same students
can afford, and so the number of course enrollments (sales) will decrease. The existence of
substitutes, such as similar courses offered online, affects demand for the campus-based
offering.
Price changes affect demand. A product that a buyer perceives as a good value when
priced at $50 likely won’t seem such a good value if priced at $100. This introduces the
concept of elasticity of demand—the degree to which demand for a product or service
varies with its price.
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Demand for a product or service is considered highly elastic when a small change in price
brings about a large change in sales. Demand for an offering is considered highly inelastic
if a big price change has little effect on sales. Every offering falls somewhere between elastic and inelastic in the eyes of any given market segment; that elasticity of demand will
vary from one segment to the next.
Consider your investment in education. Would an increase by $25 in the tuition you paid
for a course change your decision to enroll? If you answered “yes,” your demand is elastic—it snapped like a worn-out rubber band in response to a small upward change. If you
answered “no,” your demand is inelastic—a price change did not affect your demand
because of the high value you place on higher education.
Marketers strive to position offerings so that demand for them becomes more inelastic.
Companies selling products with highly elastic demand cannot raise prices, since demand
will fall off. They must instead rely on controlling costs to generate profits. Companies
selling offerings with inelastic demand have more freedom to charge higher prices and
thus generate more profits. Branding can turn even basic commodities into premiumpriced offerings. Consider bottled water: While many brands are accepted as interchangeable commodities, some consumers are quite willing to pay for the higher-priced FIJI or
Perrier brands.
Where the demand for an offering is highly elastic, consumers experience price sensitivity. They’re sensitive about how much they pay and will turn to lower-priced substitutes
if the original item they wanted is too expensive. Marketers must estimate demand and
price sensitivity when considering where to set prices. An estimate that misses the mark
will hurt revenue.
Each of a company’s offerings might experience a different level of demand, with differing degrees of elasticity and price sensitivity, in relation to different market segments. No
wonder developing a pricing strategy is complex!
As has been shown, marketers need to understand the interactivity of pricing strategy
with the other P’s of the marketing mix, how customer psychology drives perceptions of
pricing, and how elasticity of demand affects their offerings—that is, whether demand
will snap (behave elastically) in the face of price changes.
Some ways that buyer psychology affects pricing strategy are reference pricing, signposts, and perceptual cues. Also influential are sales promotions and links to social
causes, which cast prices in a new context of added value either through quantity of
goods received or quality of engagement with the brand and the social or environmental
causes in the larger world.
Questions to Consider
What situational factors might influence a marketer to make pricing strategy decisions the driver of
marketing mix decisions? Develop your own example scenarios.
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5.2 Pricing Strategies
A
company’s pricing strategy reflects the sum of its activities aimed at finding a
product’s optimum price. Pricing strategy takes into account overall marketing
objectives, consumer demand, product attributes, competitors’ pricing, and market and economic trends. The prices consumers encounter in advertising and at the point
of sale are just the tip of the iceberg. The company cannot set a price higher or lower than
customers expect. Competitors’ pricing also constrains the price range a company can
charge and yet remain competitive.
Two overarching questions must be addressed to choose an appropriate pricing strategy: whether to emphasize volume or profit, and whether to adopt a fixed or variable
approach.
Volume or Profit Maximization?
The question of volume or profit maximization represents two different objectives. In
the volume maximization approach, the company’s primary objective is to generate as
much sales volume (and revenue) as possible. On the other hand, the profit maximization approach makes the objective to generate the highest net income over time. The main
difference between volume maximization and profit maximization is the financial effect.
Volume maximization generates cash flow but can reduce profits, because companies can
find themselves selling at a loss to generate revenue. Profit maximization requires that all
sales maintain acceptable profit margins.
A clear difference between the volume and profit maximization approaches is the timeline in question. Volume maximization is a short-term strategy intended to generate sales
volume quickly. This can be effective to build up cash on hand, expand a customer base,
attract customers from competitors, or dispose of unwanted inventory. The underlying
goal is often to increase market share and reduce costs, resulting in long-term profits.
On the other hand, profit maximization addresses the profit objective directly with a focus
on positioning a brand for long-term success. In many cases, profit maximization is the
overarching goal but volume maximization takes temporary priority, for example during
the launch of a business or near the end of a quarter or fiscal year. Before marketers can
establish the pricing strategy that will form the basis for day-to-day decisions, they need
deep understanding of overall company strategy.
One Price or Many?
The varying price sensitivity among market segments introduces the possibility of
charging different prices to different segments. When different market segments have
different perceptions of value, a different price can be charged to different customers
or at different times. With this variable pricing strategy a company can generate more
revenue from market niches willing to pay higher prices and still maintain sales to those
placing a lower value on that offering. There are advantages and disadvantages to a
variable price strategy.
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A fixed pricing strategy, in which the same price is charged to all customers, is easier to
administer. Training the customer service staff and accounting for sales is easier, but the
rigidity of this policy can seem unfriendly to customers, and revenue opportunities could
be lost.
If a company chooses a fixed price strategy, it must decide whether to occupy the high,
average, or low price position. If instead a company chooses a variable price strategy, certain complications ensue—but the promise of greater revenue makes overcoming those
complications attractive.
The goal of variable pricing is to ensure that companies are selling the right product to the
right consumer at the right price, while steering clear of illegal practices. U.S. law prohibits price discrimination, defined as the practice of charging different prices to different
buyers for goods of like grade or quality.
The norms of specific industries tend to define which companies opt for a variable pricing strategy. The tiered pricing plans common among cell phone carriers are an example
of a variable pricing strategy designed to avoid problems with overburdening existing
networks while allowing carriers to make money
from mobile data and applications, rather than
just voice minutes (Wortham, 2011). Tiered pricing is legal because each tier represents a bundle
of different service options for calls, text messaging, and data usage.
Variable pricing is accepted in many parts of the
world. Haggling is an ancient form of variable
pricing. North Americans tend to expect marketers to practice a one-price policy, representing the
fundamental fairness of a democracy. A company’s strategic decision to pursue a fixed or variable pricing strategy must take this into account.
Pricing Strategies for Every Situation
Having chosen an objective of either volume or
profit maximization, and a one-price or variable
pricing approach, it falls to marketers to fine-tune
their choice of pricing strategy to fit the specifics
of their situation.
Marketers in service industries can adopt peakload pricing to counter the perishability of their
offerings. Similarly, marketers can adopt yield
management to exploit timing to generate sales
Dell Computers was one of the first to adopt
the co-creation model, offering a base price
for specific features and then encouraging
customers to customize features to create a
unique product.
Associated Press
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while managing a fixed, perishable capacity. Most people have had experience with airlines’ use of price changes to profitably manage the fit of a fixed supply to a varying
demand. Airlines change prices frequently—even minute-by-minute—depending on
their supply of seats and demand for them.
Marketers can adopt a co-creation model, in which customers bundle options to design
their own offerings that suit their individual ideas of value. A company can participate
in a dynamic pricing model, in which the buyer collaborates with the seller, allowing
retailers to offset the threat created by price comparison, which drives prices down and
narrows profit margins (Swabey, 2007).
E-commerce facilitates dynamic pricing, which gave rise to the “Name Your Own Price”
(NYOP) variation popularized by Priceline.com. Unlike the traditional seller-driven
pricing model, in which the seller prices the goods, leaving the buyer to “take it or leave
it,” the NYOP approach is buyer-driven. In response, sellers opt for opaque exchanges,
strategically withholding information from customers who may not know the exact
features of their purchase at the point of payment. Processing is fast, and competition
among customers is minimized since no one knows what anyone else is paying. NYOP
gives firms more leverage in inventory control and pricing to different segments. But in
the end, it may be a double-edged sword, making it difficult to predict profit margins
and increasing buyer-driven sales by cannibalizing seller-driven channels (Huang &
Sosic, 2011).
Marketers can signal positioning of their brands through pricing, choosing a high, average, or low price point in relation to competitors, as mentioned earlier. Skim pricing
is defined by setting prices high to attract higher-income groups for luxury or status
goods. Neutral pricing is defined by matching prices of the general market, a decision
that shifts comparison to other features of an offering. Penetration pricing is defined by
keeping prices low in comparison to competitors’ and widely promoting an offering, to
quickly achieve more sales to more buyers. Opting for a penetration price works best
when the seller intends to maintain consistency of pricing, forgoing use of sales events
or other discounts that would lower revenue even further. Walmart long held this position with its strategy of promising “everyday low pricing” with few discount sales promotions (Perner, 2008).
Field Trip 5.2: Walmart’s Everyday Low Pricing
Follow this link to an article on Walmart Watch, evaluating the company’s relaunch of an everyday low
pricing strategy in 2011.
http://makingchangeatwalmart.org/2011/10/11/high-price-of-low-cost-press-release/
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Penetration pricing de-emphasizes market segments. It works where buyers are pricesensitive and markets are large enough that thin profit margins are sustainable, but it is
highly vulnerable to competitors who match low prices (Nagel & Holden, 1995). This and
other pricing strategies are shown in the graph in Figure 5.2.
Very high
Figure 5.2: Pricing strategies that signal economic value
g
in
m
kim
Relative price
Moderate
High
S
l
ra
t
eu
Low
N
n
io
t
ra
et
Very low
n
Pe
Low
Medium
Economic value
High
Price is a signal of economic value.
Source: From Thomas Nagle and Reed Holden, Strategy and Tactics of Pricing: A Guide to Profitable Decision Making, 2nd ed. Copyright
©1994. Printed and Electronically reproduced by permission of Pearson Education, Inc., Upper Saddle River, New Jersey.
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Table 5.3 summarizes pricing strategies discussed in this chapter.
Table 5.3: Pricing strategies and objectives
Definition
Example
Use
Peak load
Charging higher prices
during periods of rising
demand
Power utilities charge
more for power during
high-demand periods to
encourage customers
to use services during
non-peak hours.
Counter the
perishability of a service
offering; viable only
when few competitors
exist.
Yield management
Strategic control of
inventory to maximize
yield or profits from
a fixed, perishable
resource
Restaurants charge less
during off-peak periods
for the same package
of seat, menu, and
service.
Counter the
perishability of a
service offering; reduce
the strain on a fixedcapacity infrastructure.
Co-creation
Allowing customers
to select from options
to design customized
offerings
Dell Computers offers
a base price for specific
features, encouraging
customers to add
or subtract features
to create a unique
product.
Meet customers’ desire
to partner with the
companies they buy
from and to customize
the value they receive.
Dynamic pricing
Buyer collaborates with
seller to establish the
price, accepting tradeoffs in exchange for
favorable pricing.
Mobile phone carriers,
electrical utilities,
Internet domain names,
auto insurance
Offset threat created by
buyers’ knowledge of
competitors’ pricing.
Opaque exchanges
Seller withholds
information from
customers about
exact features of
their purchase
until transaction is
completed.
Name Your Own Price
strategy offered by
Priceline.com
Give firms leverage in
inventory control and
pricing to different
segments.
Brand leadership (skim)
Setting prices high
in comparison to
competitors
Luxury goods
Attract higher-income
groups.
Neutral
Matching prices of the
general market
Arts organizations such
as symphony orchestras
Shift emphasis to
competing on other
aspects than price.
Penetration
Keeping prices low
in comparison to
competitors’
Walmart’s “Everyday
Low Prices”
De-emphasize market
segments.
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In a marketing era that values long-term customer relationships, both organizational buyers and consumers have come to expect a degree of flexibility in pricing. While all the
pricing strategies discussed are viable choices, those that allow for customer negotiations
are gaining in importance.
Segmented Pricing
An appropriate response for companies wanting to pursue a variable pricing strategy
while staying on the right side of the law is segmented pricing, a tactic for separating
markets and matching differentiated offerings to them.
A segmented pricing strategy is a natural extension of a company’s market segmentation
strategy. Segmentation can be an effective response to variations in segment price sensitivity and a useful tool for differentiation from competitors. In industries with high fixed
costs, such as cell phone carriers and power utilities, segmented pricing is often essential
(Nagle & Holden, 1995). Without it, the companies could never cover their costs and still
serve all the customers who need their services.
Why don’t all companies implement a segmented pricing strategy? Certain factors work
against it:
•
•
•
•
Customers don’t self-identify themselves into segments; this puts the burden on
the seller to identify segments with differing demand.
The costs of managing the segmentation program can’t be higher than the extra
revenue earned by the differences in prices.
Intermediaries can undermine the strategy by figuring out how to buy low and
sell high.
A poorly designed segmented price strategy can violate federal antitrust laws.
An extremely important factor is that whatever price a customer is charged for the value
he or she receives, that price should reflect a real difference in value from similar offerings
purchased at other price points by other customers. Otherwise, the company risks charges
of illegal price discrimination.
There is also the possibility of an outcry of consumer resentment if prices charged to different segments do not reflect a real difference in value. This happened when Adidas
charged more for rugby team shirts in the team’s home country of New Zealand than it
charged for the same shirts in other countries.
In summer 2011, when New Zealand’s hugely popular rugby team the All Blacks made
it to the Rugby World Cup, national pride soared—and so did demand for the official
team jersey. New Zealand fans went into a frenzy when they discovered shirts were being
sold online in the United States and Britain for about half the local price in New Zealand.
Local news outlets ran with the story. Anger escalated when it was reported that Adidas
told online retailers selling internationally to remove New Zealand from the available
delivery options. The Adidas brand image suffered as a result, to the extent that corporate
sponsorship events were canceled and branding removed from company vehicles after
staff members were publicly harassed (Hutchison, 2011). In a Marketing 3.0 world of connected consumers, discriminatory pricing policies will be met with consumer protest, if
not a legal challenge.
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Section 5.2 Pricing Strategies
CHAPTER 5
A segmented pricing strategy benefits consumers. It spurs competitive innovation when
companies develop improvements that different market niches will value, thus allowing
them to charge more profitable prices. Without segmented pricing, some small market
niches’ demands would more frequently go unmet.
Some segmented pricing tactics that have proven effective (and legal) include varying the
price by customer segment, demand elasticity, price sensitivity, product version, seasonality, geography, and volume purchase. Other tactics include product bundling, in which
the items combined increase
the value for a specific buyer
segment, such as an orchestra
bundling concert tickets into
a season package or an airline
offering hotel and rental car
bundled with the purchase of a
flight.
In conclusion, a pricing strategy
must reflect overall corporate
objectives regarding volume
and profitability over both short
and long time frames. Marketers may support the objective by
offering a fixed price to all customers or a price that varies by
Consumer resentment can result when the price charged to
market segment. A number of
different segments doesn’t reflect an actual difference in value.
pricing strategies serve different
Adidas learned this when it charged more for team shirts in one
purposes and situations; those
country than another.
that allow customers to particiAssociated Press pate in establishing the price are
becoming more important. A
segmented pricing strategy holds potential to yield the most revenue, as each customer
pays what he or she perceives as a fair price for the value received. However, this is the
most difficult strategy to implement.
In the end, successfully responding to the economics of pricing relies on marketers who
must find product advantages that create sustainable competitive differentiation. This is
the only way to avoid competing solely on price.
Questions to Consider
Choose one product category and describe how a segmented pricing tactic could be used to increase
revenue while steering clear of laws against price discrimination.
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Section 5.3 Inputs to the Pricing Decision
CHAPTER 5
5.3 Inputs to the Pricing Decision
A
s stated earlier in this chapter, the pricing strategy decision is driven by situational factors, including customers’ expectations, competitors’ moves, and the
company’s brand position. Strategic planning leads to pricing decisions designed
to achieve overall company objectives, as well as specific marketing objectives.
Production costs set the “floor” price, below which sales cannot translate to profits. Consumers’ perceptions create the “ceiling” price, above which there will be no demand for
the offering given consumers’ estimation of its value. In between those two points, internal and external factors exert their influence on what the price strategy will be.
Companies select a methodology by which to calculate price ranges that will meet their
volume or profit maximization goals, choosing from the following:
•
•
•
•
•
Cost-plus: Adding a standard markup to unit cost derived by adding fixed and
variable costs of production;
Target profit: Calculating breakeven costs of making and marketing a product,
selecting a price to make a target profit above that cost;
Competition-based: Setting prices based on competitors’ prices for similar
offerings;
Value-based: Using buyers’ perception of the Customer Value Equation to design
an offering that can be sold profitably at a price buyers recognize as fair; and
Markup: Adding a constant percentage to the cost paid for an item to arrive at its
selling price.
Increasingly, companies are turning to the value-based pricing method to ensure they
are offering good value at a fair price (Kotler, 2006). The value-based method offers the
most potential for competing on real points of difference among offerings, thus escaping
competition on price alone. By estimating the economic value to a customer in order to set
prices, marketers gain fundamental insight to inform all decisions of the marketing mix.
Positioning becomes the driver rather than price competition.
Strategic Planning for Pricing Decisions
Pricing decisions have far-reaching implications for the operations of an organization.
These decisions must be based on sound strategy that takes into account four influential
factors:
1.
2.
3.
4.
Costs,
Target market,
Environment, and
Differentiation strategy.
To arrive at a sound strategy, marketers apply the strategic planning process to pricing,
just as they do to arrive at strategies for the other areas of the marketing mix. Figure 5.3
shows the four influencing factors as inputs to the strategic planning process (which is
discussed in more detail in Chapter 9).
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Section 5.3 Inputs to the Pricing Decision
Figure 5.3: Inputs and processes of effective price strategy
Costs
Target market
Environment
Differentiation
Situation analysis
Objectives
Goals
Tactics
Pricing strategy
Four factors are inputs to the strategic planning process by which marketers arrive at a pricing strategy.
Strategic planning cannot be done in a vacuum. The process must begin with situation
analysis so that resulting plans take into account internal and external factors. Internal factors, such as the cost to produce the product, are relevant, as is the influence of
strategies for target marketing and competitive differentiation. Meanwhile, the environment includes an extremely important external factor affecting pricing: the psychology
of buyers.
Costs
A company’s financial managers as well as its marketers take a great interest in this input
to the pricing decision, but from different perspectives. While the financial manager is primarily interested in how high prices can be set to achieve profit objectives, the marketer
is more interested in how low prices can go, to achieve sales volume objectives. The two
must collaborate to reach a coherent pricing strategy (Nagle & Holden, 1995).
The key to determining the price at which sales will be profitable is the breakeven analysis, which calculates the point at which a company’s total sales revenues equal total
expenses. This is the lower limit a pricing strategy must deliver in sales. The analysis is
essentially a “what-if” exercise that projects the breakeven point given specific assumptions about sales volume and pricing.
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The breakeven analysis depends on four key assumptions:
1.
2.
3.
4.
The price received per unit sold;
The incremental cost, or variable cost, on average, of each unit sold;
Monthly fixed costs, those associated with normal operations of the business; and
Sales volume (how many units will be sold).
Fixed costs remain largely the same despite changes in production volume, such as rent,
insurance, and new product development, while fluctuate with production volume, for
example process materials or sales commissions.
Managers use the estimate of sales volume to calculate the variable cost total and the total
sales revenue (price multiplied by units sold). Estimating a specific sales volume allows
them to perform the following calculation:
Total fixed cost
Breakeven point (in dollars) =
1 – Cost per unit price
Managers then vary their assumptions to see how changes in the estimate of costs, sales,
or price per unit will change the breakeven point, as illustrated in Figure 5.4.
Figure 5.4: Breakeven point
ℓ̶
Income
Costs
A
C
P
Break-even
point
B
Variable
costs
Loss Profit
Fixed
costs
Q
O
Output
Estimate costs, sales, and price per unit to establish a breakeven point.
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Helpful as it is, this breakeven analysis method showing the effect of changing output
on revenue hasn’t taken into consideration consumer demand. Therefore, managers will
typically modify this approach by creating estimates of the number of units consumers
are likely to purchase at each of a series of retail prices, taking into account elasticity of
demand and potential buyers’ price sensitivity. These data can then be superimposed
onto a breakeven chart to reveal feasible prices, as shown in Figure 5.5. With this calculation, both financial managers and marketers have solid data to inform a value-based
pricing strategy.
Figure 5.5: Breakeven trade-off between price and sales volume
TR1 ($15)
Revenue at $15 per unit
Revenue at $10 per unit
Revenue at $9 per unit
Revenue at $8 per unit
Revenue at $7 per unit
Total cost
Total variable cost
$5 per unit
Total fixed cost
$40,000
Quantity
TR2 ($10)
Revenue and costs
Revenue and costs
Breakeven
points
TR3 ($9)
TR4 ($8)
TR5 ($7)
Total cost
Demand curve
Total fixed cost
Quantity
To arrive at a value-based price strategy, marketers estimate demand at various price points, taking into
account elasticity of demand and buyers’ price sensitivity.
Source: From Boone/Kurtz. Contemporary Marketing 2011, 14E. © 2011 South-Western, a part of Cengage Learning, Inc. Reproduced by
permission. www.cengage.com/permissions
Breakeven analysis will reveal feasible prices at which sales will generate revenue, based
on the seller’s fixed and variable costs and the nature of buyer demand. It’s important
to note that additional factors affect price and must be accounted for. Another tool, price
waterfall analysis, is used to model the actual profit the firm retains on a sale at a specific
price after transactional costs that impact price, such as discounts and other incentives,
have been applied.
The price waterfall begins with the list price or manufacturer’s suggested retail price
(MSRP), the price a company officially displays to buyers. Significant sums can leak away
as buyers receive promotional “give-backs” such as free shipping, volume discounts, and
bonuses for paying cash. That initial price is gradually nibbled down through transactional costs to arrive at the final pocket price the seller actually receives. The pocket price
has to cover costs, so it must reflect the breakeven point.
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In a complex distribution channel, nibbling might occur at multiple steps along the way
from manufacturer to end consumer, creating a significant “hole in the pocket.” Figure 5.6
illustrates a price waterfall for automobiles sold by General Motors.
Figure 5.6: Price waterfall
Standard
dealer
discounts
Cash
rebates
Promotional
incentives
MSRP
Invoice price
Pocket price
The price waterfall graphically represents how a list price is gradually reduced to a pocket price.
Source: Price waterfall, from Dr. Tim J. Smith, Ph.D., “GM May be Learning Price Discipline Growing Margins While Lowering Prices by
Tilting the Price Waterfall Vector,” Wiglaf Journal, December 2006. Reprinted by permission.
Target Market
For this input to the pricing decision, customers’ perception of value, the elasticity of
their demand, and their price sensitivity (which determines the maximum price feasible
to charge) come into play.
Marketers estimate the price sensitivity of buyers in the target market(s) using both the
economic and psychological factors affecting buyers. Blending these factors, marketers
can estimate a product’s economic value, defined as the reference price the buyer assigns
to the features that differentiate an offering from the alternatives available at the reference
price. The differentiating value can include negatives as well as positives. Looked at this
way, the economic value is the price that well-informed shoppers, seeking the offering
best suited to their needs, would consider a good value.
However, not all buyers make purchase decisions exactly as economic value would predict, because the expenditure is small (not worth the bother of evaluation), someone
else is paying, or a desire to impress others causes the buyer to choose a higher-priced
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Section 5.3 Inputs to the Pricing Decision
CHAPTER 5
alternative. Again, understanding distinct market niches will help marketers anticipate
responses to various price scenarios, taking into account economic value. Given the arguments in favor of a segmented price strategy, understanding the target market means
understanding many distinct market niches, each affected by economic and psychological
factors in different ways.
The target market input to pricing strategy emphasizes creating lasting relationships with
customers by delivering a satisfactory Customer Value Equation.
Environment
This input to the pricing decision covers the external factors influencing a company’s pricing decisions—economic conditions, intermediaries, competitors, and social concerns.
Economic factors such as recession, inflation, and changes in interest rates affect the
macro-environment—competitors and consumers all feel the same pressures. A price
increase may be needed to cover costs of production hurt by negative economic trends,
and yet, prospective buyers—also feeling the pinch—may be more price-sensitive than
ever. Competitors and channel partners may react to economic forces with their own
price adjustments. Both consumers and business leaders increasingly place expectations
of social sustainability on companies, creating the triple bottom line of responsibility for
social and environmental impacts as well as financial profitability. Any or all of these factors can alter the assumptions driving a breakeven analysis.
Marketers must consider the nature of the marketplace in which a company competes,
taking into account how many and what kind of competitors exist and whether the offerings for sale are uniform commodities or highly differentiated offerings. Sellers of undifferentiated offerings have little power to increase their price without losing sales volume,
unlike sellers of highly differentiated goods or services. And this leads us to the final input
to the pricing decision: differentiation strategy.
Differentiation Strategy
This input to the pricing decision involves an offering’s positioning strategy, which in turn
flows from market segmentation and targeting.
In 1980, American economist and Harvard Business School professor Theodore Levitt
wrote:
Any product can, in principle, be distinguished from the commodity mass.
The key is recognizing that what buyers purchase is more than just the
physical product or particular service exchanged. They buy an entire package—including the ease of purchase, terms of credit, reliability of delivery,
pleasantness of personal interactions, fairness in handling complaints, and
so on—that is called the augmented [enhanced] product. Even when the
physical product or service is immutable, the augmented product is invariably differentiable. (Levitt, 1980)
Differentiation strategies were covered in Chapter 3. What’s important to realize, in applying that knowledge as an input to pricing decisions, is the tremendous effect that product
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strategy has on price—and the effect that price has on product strategy, as it supports
product positioning.
Let’s consider one of the ways product strategy affects pricing: product line pricing.
Buyers’ psychological reference pricing comes into play in evaluating individual products
in a product line. When items with added features are priced in increments, the cost difference between the products signals quality or feature differences. For example, a line of
Black & Decker Dirt Devil hand vacuums begins with a basic model, topped by several
more expensive models promising added power and useful accessories at incrementally
higher prices.
Strategic planning to determine pricing should include
consideration of product line strategy. When these items are
priced in increments, the cost difference between products
signifies differences in features or quality.
Sellers naturally want to sell
more of the more-expensive
items. But buyers will rarely opt
for the highest-priced item, not
wanting to be seen as ostentatious consumers or “easy marks.”
A simple response in pricing
strategy is to set the price of the
most expensive item in the line
quite high, in effect ratcheting up
the other prices in relation to it,
which will thus position them as
better values by comparison. As
long as the seller’s marketing
messages convey quality differences between the offerings,
the strategy delivers perceived
value to buyers and profits to
the seller.
In conclusion, a company’s
strategic planning to determine
pricing strategy must consider
four factors. Production costs must be calculated to determine a breakeven point that
takes into account fixed and variable costs. The target market’s perception of the product’s economic value must be understood. External environmental factors will affect the
success of any pricing strategy. Aspects of the offering that differentiate it from competing options affect the Customer Value Equation, and so product strategy must also be
included in strategic planning to determine pricing.
dpa/Corbis
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Section 5.4 Adjusting Price Strategically
CHAPTER 5
Field Trip 5.3: Freemium Pricing
The “freemium” pricing strategy—the term is a combination of “free” and “premium”—is increasingly
being deployed. In this strategy, customers are given a basic level of service for free, with options to
pay for additional value. MailChimp, an email marketing software platform, is one example.
Follow this link to view an article about freemium pricing on the Forbes website.
7 Examples of Freemium Products Done Right
http://www.forbes.com/sites/sujanpatel/2015/04/29/7-examples-of-freemium-products-doneright/#26617e25ff72
Questions to Consider
Returning to the product category you chose in the previous section, choose one of the factors of cost,
target market, environment, or differentiation and describe how it might influence the choice of pric‑
ing strategy for an offering in that category.
5.4 Adjusting Price Strategically
S
o far our discussion of pricing strategy has focused on its role in the marketing mix as
an influence on the quantity of an offering that can be expected to sell, and the profit
those sales will generate for the seller. Now the discussion moves to the strategies
and tactics for changing prices.
About half of all companies change prices once a year or less, but as many as 1 in 10
change prices every month (Kurtz, 2010). Clearly, for most companies pricing strategy
is characterized by frequent revisions. Marketers may change their pricing strategy to
outmaneuver competitors, or to achieve a shift in potential buyers’ perception of an offering’s value. They may change prices in an attempt to increase sales volume, or to increase
profitability at the current sales volume. With so many possible effects, it’s evident that
price changes must be addressed strategically.
An increase in posted prices can be positive for a company but can anger current customers, who perceive a negative shift in the Customer Value Equation when the price
increases but nothing else about the offering changes. Price increases can be risky if marketers don’t communicate a benefit, or at least a logical need that requires the company to
pass on new costs to customers (as with gas price fluctuations). Thus price increases need
to be accompanied by strategic marketing communications.
Marketers considering a price decrease need to decide whether the change will be a shortterm strategy, lowering the base price for a stated period with a fixed end-date on which
prices revert to the original base, or a long-term strategy in which the new pricing strategy
becomes permanent.
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Reductions from the base price can be part of the permanent pricing strategy. Marketers
frequently create policies allowing cash discounts for prompt payment, trade discounts
to certain channel partners, and quantity discounts to buyers at specified volume levels.
Temporary Price Adjustments
For the rest of this discussion on price adjustment, we’ll focus on short-term strategies
that decrease prices. Note that these promotions are an integral part of the marketing plan
that can contribute to long-term objectives related to product life cycles, corporate growth
strategies, or other strategic aims.
Sales promotions are short-term marketing strategies intended to stimulate purchases
over a specific time period, by offering a reason to buy in addition to the service rendered
by the offering regardless of price. The promotion temporarily shifts the balance of the
Customer Value Equation in the buyer’s favor. That shift is intended to influence buyer
behavior for the short-term benefit of the seller, for example by encouraging switching
from another item to the one promoted, stockpiling of the promoted item, or creating an
incremental lift in overall sales.
A sales promotion is just one of many types of promotional campaigns a company can
offer. (Promotions are discussed in the next chapter on the final “P” of the marketing mix.)
A promotional campaign qualifies as a sales promotion when it involves a decreased price
intended to:
•
•
•
Encourage new customers to try an offering for the first time,
Increase recall of favorable experiences from previous trial or awareness of brand
image, or
Reward customers who have been loyally buying at full price.
Promotional pricing strategies can be used anywhere along the distribution channel—as
a pull tactic to encourage consumers to buy, or as a push tactic to encourage distributors
to sell, as described in Chapter 4. Consumer-oriented (pull) tactics include the following:
•
•
•
•
•
•
•
•
Samples: Free products distributed in hopes of obtaining future sales.
Refunds: Money returned on presentation of proof of purchase of an offering.
Premiums: Items given free or at reduced cost with purchases of other items.
Coupons: Documents that can be exchanged for a financial discount.
Contests: Prizes given to winners who are drawn from a pool of entrants who
have completed a required task.
Sweepstakes: Prizes given to winners selected by chance from a pool of entrants.
Cash rebates: Money returned on what has already been paid for an offering.
Bonuses: Payment or gift added to what is expected.
Trade-oriented (push) tactics include:
•
•
Trade allowances: Financial incentives to purchase or promote specific offerings.
Sales incentives: Programs that reward intermediaries’ superior performance.
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The feature these consumer and trade promotions have in common is that the seller forgoes some portion of the regular price to achieve one of the three objectives of promotional pricing.
A price discount creates urgency to act, which can be very helpful in meeting short-term
objectives. After all, pricing is the only “P” in the marketing mix that can be changed
quickly.
To be effective, discount promotional periods must be alternated with time periods in
which no promotions are in effect. Otherwise, consumers set their reference pricing expectations at the sale price. High-low pricing is a strategy by which marketers leverage this
tendency of consumers in their favor. The company intentionally sets its regular prices
higher than its target prices and then holds sales promotions during which prices are
lowered to the target price. This strategy is most effective when consumers in the target
market hold a strong belief that discount sales equate with better value-for-price.
An example of a pull promotional price strategy can be found in stores that offered gas
discounts to customers in the summer of 2011, when high gas prices added to the misery
consumers were already experiencing from the stagnant economy. To stimulate shopping
trips some retailers and manufacturers offered discounts on gas purchases, recognizing
that high gas prices were keeping consumers from shopping as frequently as in the past.
The Publix grocery chain offered $50 gas cards for $40 with a minimum purchase of $25
in other products. Kellogg’s asked shoppers to
send in bar codes from certain cereals to receive
a $10 gas card. CVS pharmacies gave customers a
$10 gas card when they spent $30 on certain items
(Clifford, 2011). These gas-discount sales promotions conveyed an “I feel your pain” message
more vividly than the other strategy these companies could have chosen—offering deeper discounts on products purchased in the stores. The
sellers achieved increased sales volume with their
promotional price tactic.
Sales Promotions: Too Good to Be True?
Some marketers feel that offering discounts is a
flawed strategy, suggesting that frequent sales
simply train customers to wait for sales before
they buy. While sales can increase recall of brands
and remind buyers of past positive experiences,
they do not necessarily engage consumers with
the brand or build lasting relationships. Customers who get pleasure from hunting down discounts will likely go wherever the bargains are.
The tactic of using sales promotions to reward
customers who have been loyally buying at full
price also has its critics. Some ask, why would a
company forgo sales income? Others respond that
Retailers responded to high gas prices
during the summer of 2011 with discounts
on gas purchases—a promotional price
strategy designed to stimulate shopping
trips.
Ted Soqui/Corbis
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rewards to loyal customers are justified, pointing out that competitors may be recruiting
those customers with their own sales promotions and that customers appreciate recognition of their loyalty.
Results will determine whether the criticism is valid. Sales promotions must be measured
to prove their worth as a pricing strategy. It’s important to measure the incremental sales
generated by the promotion—not total sales—to find the contribution to ROI from the
sales promotion. If the ROI isn’t there—there’s a flaw somewhere in the sales promotion
strategy.
Sales Promotions as Business Model
In 2007, as the U.S. economy weakened sharply, the demand for luxury goods dropped
dramatically—and a new business model emerged online that had sales promotions in
its DNA.
Online retailer Gilt Groupe started a members-only site to sell high-end merchandise
at deep discounts. That move launched a fast-growing trend: flash sales, featuring
designer brands at bargain prices for very limited time periods (Khalid, 2011). Originally
intended to unload excess inventory, flash sellers encountered problems in 2011. Recession-affected manufacturers cut back on production, reducing the inventory available to
be liquidated. The original flash-site sellers attempted to turn their business model from
liquidating inventory toward spotlighting brands, having observed that many buyers
who visit flash-sale sites soon buy merchandise from the same brands at full price. The
advantage of the flash-sale sites began to rest more on their ability to gather consumer
data (by tracking behavior on their sites) and less on the original inventory-management
objective (Miller, 2011).
Field Trip 5.4: Flash Sales as Business Model
Search on the terms “flash sale discounting” using your favorite search engine to discover the current
state of flash retailing. Is Gilt Groupe still the dominant player?
You could start your research with this article from Ad Age DIGITAL from September 19, 2011:
Think Consumers Are Tired of Deals? Better Think Again
http://adage.com/article/digital/consumers-tired-deals/229862/
The “deal of the day” site Groupon is an example of a business model designed to leverage consumer interest in sales promotions and social media. The company offers one
“groupon” each day in each of the markets it serves. If a certain number of people sign
up for the offer, then the deal becomes available to all. This gives the offer a social component—by forwarding Groupon offers to friends, consumers can increase the likelihood the
deal will become available. This reduces risk for retailers too, who can treat the coupons
as quantity discounts as well as sale offers. (Groupon makes money by keeping about half
the list price of the coupon.) However, participating in a Groupon deal can prove to be an
unprofitable prospect for retailers who must use deep discounts to attract customers to a
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daily deal. Retailers need to carefully calculate how many coupons they can validate and
still make money (Carrera, 2011).
In conclusion, it’s important for marketers to recognize how changing prices changes
everything else in the marketing mix. Giving up profits is something no company would
do without a defensible reason. Price changes can address internal objectives, such as a
need to liquidate excess inventory, a desire to increase sales volume, or a way to facilitate
campaign measurement. A price change can address external factors, such as signaling
a shift in positioning to the target market. Any of these reasons offers sufficient benefit
to warrant including sales promotions as part of a company’s overall pricing strategy.
It’s important that the discount be used strategically—that is, to address one of three
objectives:
1. Encourage first-time trial,
2. Increase engagement between seller and buyer, or
3. Reward loyalty.
Questions to Consider
Many people consider shopping for bargains to be part of their everyday “financial fitness routine.”
Some take it to such lengths they identify as “extreme couponers.” Do you look for sales promotions
and price discounts when you shop? Does the type of item you are shopping for affect your interest in
discounts and sales promotions? Would you pass up buying your favorite brands to save money? What
could marketers learn by observing your behavior with regards to strategic use of sale pricing?
5.5 Challenges to Effective Pricing Strategies
T
hroughout this chapter, we’ve made the case that pricing decisions must be strategic to produce results. But certain challenges counter any organization’s efforts to
develop and implement effective pricing strategies.
Perhaps the most important constraint is the need to stay within the bounds of all applicable laws. Beyond the rule of law lies the moral ground of doing what is right. Today’s
consumers are harsh in their judgment and quick to share their opinions when they perceive a company as unfair to some or all customers. Also challenging for decision-makers
regarding pricing are potential conflicts of interest with distribution channel partners,
and the difficulties of selling in the B2B model. Taken together, these constraints increase
the operational complexities of managing pricing strategies. A closer look at each follows.
Ethics and Legality
Is it fair for different people to pay different prices for the same thing? Should a student
and a millionaire pay the same for a gallon of milk? Should a person in the United States
and in a poorer country in Africa pay different prices for a cancer-treating drug? These
questions are not easily answered. Discounted prices for those on fixed incomes, such as
students or senior citizens, have been a visible part of retail pricing structures for decades.
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But less transparent use of segmented pricing can backfire, as examples mentioned earlier
have shown. In a Marketing 3.0 world, consumers increasingly bring an expectation that
they will be able to customize offerings to their own tastes, that such customization will
not be reflected in high prices, and that in many cases they will be able to collaborate on
what the price will be (Name Your Own Price) as well as what features are included in
that price. These trends make more opaque just what each customer pays and what each
customer gets, mitigating somewhat the potential of segmented pricing to be perceived as
unfair. How marketers frame their prices as part of their positioning strategy has much to
do with perceptions of the ethics of their pricing practices.
Marketers not only risk consumer dissatisfaction but also legal sanctions if their pricing
strategies are unethical or illegal. Since 1890, the federal government has acted to maintain
fair price competition through antitrust law. The United States maintains stringent laws;
the rest of the world is following suit, although traditionally European and Asian countries impose fewer constraints through law (Perner, 2008). Failure to comply can bring
risk of substantial fines and even prison sentences. Practices such as requiring a customer
to buy a less-desired product in order to buy a more desired one, collusion among businesses to fix prices, price discrimination (selling identical products to different buyers at
different prices), or predatory pricing (temporarily selling below a sustainable price to
undermine competition) are illegal. A deeper study of pricing law falls outside the intent
of this introductory book but is essential for any marketer responsible for organizational
pricing strategy decisions.
Channel Conflicts
Members of a distribution channel may find they have conflicting interests. Any partner in the
channel may seek to increase
profits or sales volume at the
expense of other channel partners. For example, retailers seeking to maximize category profits
may offer promotional pricing
on one brand and thus hurt a
competing brand’s sales, since
consumers can easily switch if
one brand goes on sale. Retail- Channel partners can have conflicts of interest arising from
ers may advertise a few highly pricing decisions, as when a retailer advertises a sale price on
discounted items to generate one brand and thus hurts competing brands’ sales.
store traffic; the manufacturers
Associated Press
of those items may resent the
positioning effect of the deep
discount, which can send a message that the item is low-quality or being discontinued.
As discussed in Chapter 4, channel partner relationships are difficult to change, so channel conflicts arising from pricing decisions can cause significant disruption that is hard to
repair.
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Section 5.5 Challenges to Effective Pricing Strategies
CHAPTER 5
Selling to Organizations
Selling goods and services to organizations can be substantially more complex than selling
to consumers. In a business, the single consumer is replaced by an organizational function, termed the buying center, in which several people participate in the buying decision. Initiators, users, buyers, gatekeepers, and deciders may all be involved in the buying
center (Nagle & Holden, 1995). Initiators generate purchase requests, users help identify
specifications for the purchase, and buyers have the formal responsibility to authorize
the purchase. Large organizations will have dedicated purchasing agents while smaller
organizations may be less structured, making it difficult for a seller to identify who holds
buying responsibility or authority. Also influencing the buying process in an organization
are gatekeepers who control the flow of information and contact with the buying center,
and deciders (who may be the buyer or may serve in a less visible role) who have the
final authority to select a vendor. Businesses selling to other businesses need a sales staff
knowledgeable in the subtle dynamics of the buying center. Too frequently salespeople
underestimate the impact or fail to understand the perspectives of the different individuals in the buying center.
Managing Complexity
“More and more, today’s pricing environment increasingly demands better, faster, and
more frequent pricing decisions than ever before. It is also forcing companies to take a
whole new look at pricing and its role in an increasingly complex marketing environment” (Gould, 1979). That statement was originally published in Business Week in April
1974, but it is just as relevant today. The humanity-centric consumers of the Marketing 3.0
era, who demand responsibility to a triple bottom line of economic value, environmental health, and social progress in the companies they do business with, are not likely to
buy from sellers who fail to offer full transparency about pricing or to involve customers
as collaborative partners in creation of value. Pricing strategies must reflect authenticity,
including authentic differences in value for each market niche under a segmented pricing
strategy. Positioning strategies must reflect clear competitive differentiation, to move the
conversation away from price toward economic value.
The key to managing these complexities lies in tracking the effectiveness of the strategy in
use. Information on how current strategic decisions perform is the best tool for deciding
whether to change or maintain the current strategy, and if a change is warranted, what
strategic direction it should take.
Field Trip 5.5: Finding the Best Value in Film Transfer Services
In the previous chapter you learned about film transfer services’ use of distribution strategies as a
competitive differentiator. Now, return to the world of film digitization for a lesson in the complexities
of pricing strategies.
Visit three film transfer services’ websites (search on “film transfer” to select your consideration set)
and examine their posted prices. Assume you have three 5-in. reels of Super 8 mm film you would like
transferred. Can you compare prices? What factors, such as quality of transfer and turnaround time,
affect the price? Can you ascertain which vendor offers the best economic value for you?
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CHAPTER 5
Case Study: Price War in Mariachi Plaza
The concerns discussed above make any organization’s pricing decisions complex. Ethical
and legal matters, channel partners’ perspectives, and the functional and psychological
factors affecting the buying center in a business-to-business purchase exchange are all
challenges to any organization’s pricing decisions. Pricing decisions directly affect sales
volume and profitability, and indirectly affect the other aspects of the marketing mix: what
is designed into the offering to give it economic value (Product), its effect on intermediaries in the distribution channel (Place), and the objectives and effectiveness of advertising
(Promotion). In the end, it is the customers in the targeted market segment who make the
decision about which offering presents the best value and who have the most input on a
company’s pricing strategy.
Questions to Consider
Apply what you have learned about today’s consumer from this and previous chapters. Do you see
challenges to effective pricing strategies arising from expectations of consumers in the Marketing
3.0 era? How is pricing strategy affected when consumers reach for fulfillment of their higher needs
through their buying decisions?
Case Study: Price War in Mariachi Plaza
I
n a corner of the Boyle Heights neighborhood just east of downtown Los Angeles you’ll
find Mariachi Plaza—a long-established hiring center for musical ensembles that play
the traditional music of western Mexico. Mariachi musicians play party music for christenings, quinceañeras, weddings, and other celebrations in Los Angeles’s Latino community, wearing the silver-studded
costumes and wide-brimmed
sombreros characteristic of the
Jalisco region. Mariachi Plaza,
an established marketplace for
the bands since the 1940s, has
become an attraction in its own
right, with huge murals and a
bandstand. The musicians for
hire there are professional entertainers who are well-paid for
their performances.
Many musicians in Mariachi Plaza have had to drop their
rates to book an event as the demand has dropped and more
competitors fill the marketplace.
Associated Press
Or were. A dispute over what
they should charge heated
up in the summer of 2011,
reported in the New York Times
(Medina, 2011). Since about
2000 the established musicians
of Mariachi Plaza—and their
customers—knew how much a
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Case Study: Price War in Mariachi Plaza
CHAPTER 5
mariachi should charge. The going rate had been about $50 per hour for each musician
in the ensemble. By a decade later, two factors were challenging the status quo—a 50
percent drop in demand for bookings and a rise in competition from newcomers, some
willing to lower their rate to $30 per hour. Some also began charging only for time played,
not including charges for travel and setup, which further undercut the common pricing practices of Mariachi Plaza. The old-timers shared an opinion that the newer musicians brought a lower artistic quality, lacked knowledge of the traditional song repertoire,
and even fell short in their costuming (Hoag, 2011). Shouting matches and even fistfights
erupted over who would get gigs, the Times reported.
In 2011, roughly 150 of the 400 musicians formed a group to set a minimum price expectation (Hoag, 2011). Those who joined the United Mariachi Organization of Los Angeles
agreed to pay $10 a month and to hold the line at $50 an hour, in return for a photo identification card marking them as authentic practitioners with high professional standards.
The organization helps its members deal with booking contracts; complaints of bounced
checks and reneged-on prices have been numerous.
Consider the situation from the point of view of the (fictional) recently arrived musician
Jose Aguinaga, whose talented ensemble Grupo Danzón was well-respected in Jalisco
before arriving in the United States. Should he and his musicians cast their lot with the
professionals who join the United Mariachi Organization or side with the newcomers
who, due to their lower rates, are more likely to find work? Pricing strategy is crucial to
Jose’s success in the music business.
How is psychology affecting potential buyers’ decisions about entertainers in Mariachi
Square? If they’ve booked bands there in the past, they may be familiar with the reference
price point of $50 per hour per musician established a decade ago. More recent customers
may be unaware of the downward trend and fix on $30 as “fair.” Customers’ perception
sets the “ceiling” price Jose can charge. Jose will need a pricing strategy that recognizes
his potential customers’ price sensitivity.
He sets the “floor” with a breakeven analysis that factors in his fixed and variable costs,
including instruments, costumes, and the pay he and his band members need to support
their families. Complicating this calculation is Jose’s need to charge enough to cover the
periods when the band is not working—unpredictable at best. Inputs to Jose’s strategic
pricing plan, in addition to costs, include the characteristics of the target market (with its
reference pricing), environment (competitive), and his choice of differentiation strategy.
Is segmented pricing an option for Grupo Danzón? Several of the segmentation tactics
listed in this chapter could be effective: The band could vary prices by form (offering different musical sets designed to appeal to different market niches), by geography (charging
for travel), by purchase quantity (offering discounts for multiple bookings), or by product
bundling (adding party planning to the band’s service offering), for example.
Jose knows he must find a competitive differentiation strategy that will allow him to
become profitable by charging higher prices. Jose’s pricing strategy will have to be neutral, as opposed to a skim or penetration approach, because Los Angeles’s mariachi bands
have been experiencing a declining stage in the Product Life Cycle relative to their popularity in the 1950s and 1960s, but mitigated by the steady growth of the area’s Hispanic
population.
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Case Study: Price War in Mariachi Plaza
CHAPTER 5
He must find a way to stand out for something other than price. As a newcomer he needs
to encourage trial by new customers who, if satisfied, will reward him with referrals and
future bookings. Joining the United Mariachi Organization will position him as part of a
proud heritage, “the real deal” among imitators.
Sales promotions have proven effective to encourage trial. In sales promotions Jose has
found his differentiating factor; few other mariachi bands have adopted this technique. To
stand out among the Union members, Jose Aguinaga and his Grupo Danzón begin offering free samples in the form of music videos on DVDs, accompanied by coupons promising a 20 percent discount from his posted rate of $50 per hour per musician. On the disc, in
addition to his band’s traditional Jalisco musical stylings, he includes videos showcasing
several updated genres Grupo Danzón has mastered—including tunes by Pink Floyd and
Michael Jackson. There’s no group in Mariachi Plaza quite like them. Tracking redemption
of the coupons will let Jose know if his strategy is effective—as will the buzz his unusual
take on Mariachi music creates. (Will the videos go viral on YouTube?)
Fundamentally, pricing for mariachi bands is a function of supply and demand. With
demand falling relative to supply, the musicians are experiencing increasing elasticity of
demand. Those who want to work must develop strategic responses, including finding
new ways to promote themselves beyond the boundaries of Mariachi Plaza. Those who
wish to use Mariachi Plaza as a marketing venue should respect its traditions—including
pricing structure.
Challenge Question
When customers grow accustomed to negotiating prices, whether through haggling, customizing, or
Name-Your-Own-Price exchanges, a company loses some degree of control over the profitability of
each sale. Therein lies the appeal of a return to a fixed-price strategy. But this chapter has argued that
a segmented price strategy, in which a company charges different prices to different customer seg‑
ments, yields more revenue. Is there a difference between a fixed-price policy and a one-price policy?
Does a segmented pricing policy undermine the relationship between price and value?
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Post-Assessment
CHAPTER 5
Post‑Assessment
1. Law firms were among the last user groups to give up the computer program
WordPerfect for document processing because of the cost of converting large
libraries of document templates to new software. Which term BEST applies to
this example?
a.
b.
c.
d.
Reference pricing
Signposts
Switching costs
Price sensitivity
2. Which of the following BEST describes the nature of a demand curve in terms of
the relationship of supply to demand?
a.
b.
c.
d.
A slope downward as price decreases and quantity increases
A slope upward as price decreases and quantity increases
A slope downward as quantity decreases and price increases
A slope downward as quantity and price decrease
3. Which pricing strategy is associated with reducing strain on infrastructure with a
fixed capacity?
a.
b.
c.
d.
Peak load
Dynamic pricing
Yield management
Opaque exchange
4. Which of the following is NOT a component of the environment factor that
affects pricing decisions?
a.
b.
c.
d.
Competitors
Social concerns
Target profit
Economic conditions
5. When a clothing retailer temporarily adjusts prices downward to get rid of last
season’s fashions, that is an example of a:
a.
b.
c.
d.
Pull tactic
Sales promotion
Trade allowance
Premium
Answers
1. c. Switching costs. The answer can be found in Section 5.1.
2. a. Slope downward as price decreases and quantity increases. The answer can be found in Section 5.1.
3. c. Yield management. The answer can be found in Section 5.2.
4. c. Target profit. The answer can be found in Section 5.3.
5. b. Sales promotion. The answer can be found in Section 5.4.
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Critical Thinking Questions
CHAPTER 5
Key Ideas to Remember
•
•
•
•
•
The price established for a product or service is critical because the price affects
the Customer Value Equation. Psychological factors and economic principles
affect buyers’ purchase behavior, which influences sellers’ pricing decisions.
Economic concepts that affect pricing strategy include supply and demand,
elasticity of demand, price sensitivity, and the breakeven point. In light of these
effects, marketers should consider a segmented pricing strategy that identifies
specific markets and matches differentiated offerings to them, because of the
strategy’s potential to maximize revenue, even though a segmented strategy is
difficult to implement.
Inputs to the pricing decision include costs, target market, environment, and differentiation strategy. Cost takes into account the breakeven analysis, which sets
the “floor” below which prices cannot yield profit and the “ceiling” above which
customer demand falls off. Target market involves customers’ perception of value,
the elasticity of their demand, and their price sensitivity. Environment includes
external factors such as economic conditions, intermediaries, competitors, and
social concerns. Differentiation strategy recognizes the interactivity of product
strategy and price in creating a product’s positioning.
Adjusting prices via short-term sales promotions can achieve strategic objectives,
including encouraging first-time trial, increasing engagement between seller and
buyer, and rewarding loyalty. Sales promotions must be measured to track their
incremental contribution to sales.
Pricing decisions are made more complex by challenges that include ethical and
legal matters, channel partners’ perspectives, and the certain complications unique
to business-to-business purchase exchanges. Pricing decisions interact with the
other four P’s of the marketing mix, directly affecting sales volume and profitability.
Critical Thinking Questions
1. If you were starting a coffee shop across the street from a Starbucks, how might
you use buyer psychology concepts discussed in this chapter (reference pricing,
signposts, sale signs, and prices ending in 9) to set your pricing strategy?
2. What differentiates a sales promotion from other price adjustments?
3. Identify factors influencing elasticity of demand.
4. Explain how calculating the breakeven point and estimating consumers’ price
sensitivity assist in price determination.
5. Give examples that demonstrate how the economic concepts of supply and
demand, elasticity of demand, price sensitivity, and breakeven point affect pricing strategy.
6. Consider a locally owned hardware store that competes with several nationalbrand “big-box” stores in its trade area. Justify which is better for the hardware
store: a pricing strategy that features a sale once a month, or everyday low pricing. Explain your thinking.
7. Project a future in which the business model for flash sale websites focuses on
spotlighting brands and using data gathered by tracking individual consumer
behavior on the site. Could a segmented pricing strategy work for these “secondgeneration” flash sale sites? Could a “Name Your Own Price” strategy work?
Explain your thinking.
8. How does the concept of value-based pricing lead to a variable pricing strategy?
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CHAPTER 5
Key Terms to Remember
Key Terms to Remember
bonuses A consumer-oriented promotional strategy involving payment or gift
added to what is expected.
breakeven analysis The point where total
revenue received equals the total of fixed
and variable costs associated with the sale
of the product.
buying center Within a business, a functional unit charged with evaluating and
purchasing goods and services. Initiators,
users, buyers, gatekeepers, and deciders
may all be involved in the buying center.
cash rebates A consumer-oriented promotional strategy involving money returned
on what has already been paid for an
offering.
co-creation model Buyers may bundle
options to design products that suit their
individual ideas of value.
competition-based A pricing approach
focused on setting prices based on competitors’ prices for similar offerings.
contests A consumer-oriented promotional strategy involving prizes given to
winners who are drawn from a pool of
entrants who have completed a required
task.
cost-plus A pricing approach focused on
adding a standard markup to the cost of
the product that accommodates fixed and
variable costs of production.
coupons A consumer-oriented promotional strategy involving documents that
can be exchanged for a financial discount.
dynamic pricing model Buyers and sellers collaborate to establish a price, accepting trade-offs in deliverables for favorable
pricing.
economic value The reference price that
a buyer assigns to the features that differentiate an offering from the alternatives
available at the reference price.
elasticity of demand The degree to
which demand for an offering varies with
its price. Demand is highly elastic when
a small change in price brings about a
large change in sales, highly inelastic if a
large price change has little effect on sales
(demand).
equilibrium point The position of a market price that generates an equal amount
of demand and supply for a product or
service.
fixed costs Costs associated with normal
operations of the business, such as rent
or insurance, that do not change with
changes in production volume.
fixed pricing strategy A strategy in which
the same price is charged to all customers,
as opposed to a variable pricing strategy.
flash sales A trend beginning in 2007 of
members-only websites selling designer
brands at bargain prices for very limited
time periods while collecting consumer
data by tracking online behavior.
high-low pricing A strategy in which
a company intentionally sets its regular prices higher and then reduces the
price structure during frequent sales
promotions.
list price A manufacturer’s, distributor’s, or retailer’s quoted, published, or
displayed price on which discounts are
computed. Also called manufacturer’s suggested retail price (MSRP).
markup Adding a constant percentage
to the cost paid for an item to arrive at its
selling price.
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CHAPTER 5
Key Terms to Remember
manufacturer’s suggested retail price
(MSRP) See list price.
neutral pricing A strategy calling for
matching prices of the general market.
opaque exchanges Buying exchanges
in which sellers strategically withhold
information from customers who may not
know the exact features of their purchase
at the point of payment, a feature of the
Name Your Own Price approach.
peak-load pricing Charging higher prices
during periods of rising demand (viable
only when few competitors exist).
penetration pricing A strategy calling
for keeping prices low in comparison to
competitors’ and widely promoting an
offering, to quickly achieve the most sales
to the most buyers possible.
pocket price The price collected by a seller
in a particular transaction after accounting
for all relevant discounts given to channel
partners or the end consumer.
premiums A consumer-oriented promotional strategy involving items given free
or at reduced cost with purchases of other
items.
price The money or other consideration
exchanged for the ownership or use of a
good or service, representing a quantifiable way to measure the value customers
place on that offering.
price discrimination The practice of
charging different prices to different buyers for goods of like grade or quality, prohibited under the Clayton Act as amended
by the Robinson-Patman Act.
price sensitivity The amount by which
changes in a product’s cost tend to affect
consumer demand for that product.
price waterfall analysis A tool used to calculate how much revenue companies keep
from each sale after transactional costs
have been subtracted.
profit maximization A strategic approach
with the objective of generating the highest
possible net income over time.
reference pricing In buyer psychology,
an amount representing a fair price in the
consumer’s mind that is remembered,
researched, or inferred from the buying
situation.
refunds A consumer-oriented promotional strategy involving money returned
on presentation of proof of purchase of an
offering.
sales incentives A promotional strategy
involving programs that reward intermediaries for superior performance.
sales promotions A short-term marketing
strategy intended to stimulate purchases
over a specific time period, by offering a
reason to buy in addition to the service
rendered by the offering regardless of
price.
samples A consumer-oriented promotional strategy involving free products distributed in hopes of obtaining future sales.
segmented pricing Selling a product or
service at more than one price, where the
difference in prices is based on differences
other than costs of production.
signposts In buyer psychology, the tendency of reference prices on certain items
to signal a store’s pricing in general.
skim pricing A strategy calling for setting
prices high to attract higher income groups
for luxury or status goods, or to extract
maximum returns from a market before
competitors emerge.
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CHAPTER 5
Key Terms to Remember
supply and demand The amount of a
product sellers make available (supply)
and the amount buyers want to purchase
(demand).
value-based A pricing approach focused
on using buyers’ perception of value
to design an offering that can be sold
profitably.
sweepstakes A consumer-oriented promotional strategy involving prizes given to
winners selected by chance from a pool of
entrants.
variable cost A cost that fluctuates with
production volume; for example, process
materials or sales commissions.
switching costs The costs associated with
switching suppliers when the purchase
will require buyers to spend on additional
goods or services to gain its full value.
target profit A pricing approach focused
on calculating breakeven costs of making
and marketing a product, and selecting
a price to make a target profit above that
cost.
trade allowances A promotional strategy
involving financial incentives to channel
partners to purchase or promote specific
offerings.
variable pricing strategy A strategy in
which different prices are charged to different customers or at different times.
volume maximization A strategic
approach in which a company’s primary
objective is to generate as much sales volume (and revenue) as possible over a short
time frame.
yield management Strategic control of
inventory to maximize yield or profits
from a fixed, perishable resource.
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6
Josh Gosfield/Corbis
The Marketing Mix: Promotion
Learning Objectives
After studying this chapter, you should be able to:
• Discuss branding in terms of the contributions of consumers and marketers.
• Identify message channels in terms of their control.
• Recall three aspects of promotions requiring decisions as part of the Promotions Mix.
• Discuss marketing messages in terms of strategy, structure, and creative approach.
• Demonstrate understanding of three issues affecting promotions decisions in
today’s marketplace.
• Explain why Integrated Marketing Communications (IMC) cannto be ignored in
today’s marketing practice.
• Recall three communication strategies that can be deployed in a global marketing
program.
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Section 6.1 Branding: The DNA of Promotions
CHAPTER 6
Introduction
M
ost marketing activity leads to communication activity of one kind or another,
ranging from traditional advertising to cutting-edge conversations via social
media. We begin exploring that communication activity with the core concept
of developing and communicating branding. Then we move to how promotional strategies are evolving under the influence of media convergence and increasing capacities for
one-to-one conversations with customers and prospects. The chapter closes with a look at
the implications of humanity-centric Marketing 3.0 and access to global markets for the
Promotion aspect of the marketing mix.
Promotion joins Product, Place, and Price as a “P” in the marketing mix. Promotional
strategy affects three decision areas:
1. Marketing mix strategies;
2. Achieving effective market segmentation, targeting, and positioning; and
3. Enhancing revenues and profitability.
The need for organization-wide coordination and for integration of consumers into the
process is fundamental to understanding Promotion’s role in the marketing mix. As you
learn about the role of promotions in marketing, keep in mind this need for cross-functional coordination.
6.1 Branding: The DNA of Promotions
P
romotion is defined as the function of informing, persuading, and influencing consumers’ purchase decisions. With that in mind, our discussion of promotion must
begin with how consumers experience being recipients of all that communication.
Receiving attention from a marketing organization is a lot like being pursued by somebody who wants to get to know you. Promotions trigger social cues deeply embedded in
human psychology. Branding is the result.
As individuals we quickly sense the personalities of others we meet based on the social
cues they send us such as posture, appearance, and style. A brand does for a company
what a personality does for an individual—it presents a unique (differentiated) identity
that hopefully attracts and retains social relationships. A flawed personality repels rather
than attracts; so does poor branding.
In the Marketing Era born out of the postwar proliferation of products...
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