IIM Lucknow IPMX Co. 27

Chapter 11: Managing Pricing and Sales Promotions

IPMX Marketing Management โ€” Comprehensive Study Notes

๐Ÿ“Œ Chapter Overview

Opening Case: Netflix โ€” Founded 1997; grew to 74M US subscribers + 210M worldwide. Challenge: rising content costs while maintaining value perception. Strategy: tiered pricing (Basic $8.99 / Standard $10.99 / Premium $15.99); India: mobile-only โ‚น199 plan + partnership with Jio for free subscription to postpaid customers. CEO Hastings: "Price is all relative to value... we're continuing to increase content offering." Result: 14% OTT market share in India by July 2021.

Critical distinction: Price is the ONE element of the marketing mix that produces REVENUE. All others produce COSTS.

๐Ÿง  Key Concept: What Price Is

Price comes in many forms: rent, tuition, fares, fees, rates, tolls, retainers, wages, commissions.

Historical context: Fixed prices emerged only in late 19th century with large-scale retailing (F.W. Woolworth, Tiffany & Co.). Before: everything was negotiated.

Internet revolution in pricing:

๐Ÿ”ท Framework 1: Common Pricing Mistakes

  1. Setting prices based only on cost (cost-plus thinking)
  2. Not revising prices frequently enough to capitalize on market changes
  3. Setting prices independently of the rest of the marketing program
  4. Not varying prices enough across segments, channels, and occasions

๐Ÿ”ท Framework 2: Consumer Psychology and Pricing

Reference Prices

Consumers compare observed prices to internal reference points. Types:

Managerial use: Sellers manipulate reference prices by:

Warning: "Unpleasant surprises" (price higher than expected) have GREATER negative impact on purchase likelihood than pleasant surprises have positive impact.

Price framing: "$600 annual membership" feels less than "$50 per month" even though they're equal. Breaking into smaller units reduces perceived expense.

Image Pricing

Price as a quality indicator โ€” especially for ego-sensitive products: perfumes, cars, designer clothing.

Ferrari effect: Deliberately limits production below demand to maintain exclusivity and justify premium.

Pabst Blue Ribbon in China: US budget beer repositioned as premium ($44/bottle) by claiming "matured in precious wooden cask like Scotch whiskey" โ€” same product, completely different positioning.

Pricing Cues

๐Ÿ”ท Framework 3: The 6-Step Price-Setting Process

Step 1: Define Pricing Objective
         โ†“
Step 2: Determine Demand
         โ†“
Step 3: Estimate Costs
         โ†“
Step 4: Analyze Competitors' Prices
         โ†“
Step 5: Select Pricing Method
         โ†“
Step 6: Set the Final Price

Step 1: Define Pricing Objective

Objective How Price is Set When Used
Short-term profit maximization Maximize current profit/ROI When firm knows demand and cost functions well
Market penetration Very low price โ†’ maximize volume โ†’ lower costs Price-sensitive market; discourages competition
Market skimming High price โ†’ "skim cream" off high-WTP buyers New technology; sufficient buyers at high price; high price โ‰  more competition
Quality leadership High price + heavy R&D investment to maintain quality Starbucks, BMW, Aveda

Penetration conditions (all 3 must hold):

  1. Market is highly price sensitive
  2. Production/distribution costs fall with accumulated experience
  3. Low price discourages actual and potential competition

Skimming conditions:

  1. Sufficient buyers signal high current demand
  2. High initial price doesn't attract more competitors
  3. High price communicates image of superior product

Step 2: Determining Demand

Price Elasticity of Demand: = % change in quantity / % change in price

Figure 11.1 (Inelastic vs Elastic):

Academic finding: Average price elasticity across all products, markets, time periods = -2.62. Meaning: 1% price decrease leads to 2.62% sales increase.

When demand is inelastic (price elasticity is LOW):

  1. Product is distinctive with few/no substitutes
  2. Consumers don't readily notice price increase
  3. Consumers are slow to change buying habits
  4. Consumers think higher price is justified (scarcity, quality, taxation)
  5. Expenditure is small % of buyer's total income
  6. Part or all of cost borne by another party

Long-run vs Short-run elasticity: Often differs. Buyers may stick with supplier after price increase initially but switch later (more elastic long-run). Or drop supplier then return (less elastic long-run).

Step 3: Estimating Costs

Fixed costs: Don't vary with production/sales (rent, heat, interest, salaries) Variable costs: Vary directly with production level (materials per unit = constant per unit, but total varies) Total cost = Fixed + Variable Average cost = Total cost / Production units

Experience Curve (Learning Curve):

Example (Samsung tablet):

Experience-curve pricing strategy (and risks):

Activity-based cost accounting: Needed to estimate real profitability per customer/retailer type โ€” goes beyond standard manufacturing cost accounting.

Step 4: Analyzing Competitors' Costs, Prices, Offers

Value players disrupting incumbents: Aldi, Lidl, JetBlue, Southwest Airlines โ€” high quality + low price combination threatens traditional players. Key: serve one/few segments + highly efficient operations.

"Set up low-cost operations only if (1) existing businesses become more competitive as a result, and (2) new business derives synergy advantages."

Continental "Lite" and United's "Ted" โ€” failed due to lack of synergies. ING Direct, First Direct โ€” succeeded through synergies with parent.

Step 5: Selecting a Pricing Method

The Three-Cs framework:

5 Pricing Methods

1) Markup (Cost-Plus) Pricing:

Unit Cost = Variable Cost + (Fixed Cost / Unit Sales)
         = $10 + ($300,000 / 50,000) = $10 + $6 = $16

Markup Price = Unit Cost / (1 - Desired Return on Sales)
             = $16 / (1 - 0.20) = $16 / 0.80 = $20

Why markup pricing persists despite ignoring demand:

2) Target-Rate-of-Return Pricing:

Target-Return Price = Unit Cost + (Desired Return ร— Invested Capital / Unit Sales)
                    = $16 + (0.20 ร— $1,000,000 / 50,000) = $16 + $4 = $20

Break-Even Volume = Fixed Cost / (Price - Variable Cost)
                  = $300,000 / ($20 - $10) = 30,000 units

(See Figure 11.2: Break-Even Chart showing total revenue crossing total cost at 30,000 units)

Limitation: Ignores customer demand and competitor prices.

3) Economic-Value-to-Customer (EVC) Pricing: = Price based on customer's perceived economic value = Buyer's image of product performance + channel deliverables + warranty quality + customer support + supplier reputation

Caterpillar Example:

Key: Customers must actually perceive this value โ€” requires communication and education.

4) Competitive Pricing (Going-Rate): = Price based largely on competitors' prices

5) Auction-Type Pricing:

Step 6: Setting the Final Price

Price discrimination = Selling at 2+ prices not reflecting proportional cost differences.

Type Definition Example
First-degree Charge each customer their personal max WTP Custom negotiations
Second-degree Less for larger volumes Airlines, cell phones (though some charge MORE with higher usage)
Third-degree Different prices to different segments โ†’ See below

Third-Degree Price Discrimination Types:

Conditions for price discrimination to work:

  1. Market is segmentable AND segments show different demand intensities
  2. Lower-price segment cannot resell to higher-price segment
  3. Competitors cannot undersell the firm in the higher-price segment
  4. Cost of segmenting/policing must not exceed extra revenue
  5. Must not breed customer resentment

Yield Management: Airlines/hotels/cruise lines offer discounted early purchases, higher late prices, lowest just-before-expiry rates. Example: same NYC-Miami flight, some pay $200, others $1,290.

Dynamic Pricing: Online merchants on Amazon change prices hourly or by the minute to secure top search placement.

๐Ÿ“Š Figure 11.1: Inelastic vs Elastic Demand

(From textbook page 15)

Inelastic: steep demand curve โ€” price increase from $10โ†’$15 moves quantity only from 105โ†’100. Elastic: flat demand curve โ€” same price increase moves quantity from 150โ†’50.

๐Ÿ’ก Groupon Case Study

โŒ Common Mistakes

  1. Ignoring price psychology โ€” Not using reference prices, image pricing, or pricing cues strategically
  2. Treating price as independent โ€” Price must align with positioning and rest of marketing mix
  3. Cost-only pricing โ€” Missing the ceiling (customer value) and the orienting point (competition)
  4. Not varying prices enough โ€” Leaving money on the table from high-WTP customers; not capturing cost savings from serving different segments
  5. Price wars โ€” Usually destroy value for everyone; better to differentiate and escape commodity trap
  6. Raising prices without value justification โ€” Customers notice and resent it

๐Ÿ“‹ Quick Revision

Price psychology: Reference prices | Image pricing | Pricing cues (odd endings, "9" signals discount)

6-Step process: Objective โ†’ Demand โ†’ Costs โ†’ Competitor analysis โ†’ Method โ†’ Final price

Pricing objectives: Profit maximization | Market penetration | Market skimming | Quality leadership

Pricing methods: Markup | Target-rate-of-return | Economic value to customer | Competitive | Auction

Price floor = costs; Ceiling = customer value; Orienting point = competitors

Price elasticity average = -2.62 (1% drop โ†’ 2.62% volume increase)

Price discrimination types: 1st degree (individual) / 2nd degree (volume) / 3rd degree (segment)

๐ŸŽฏ Self-Quiz Questions

  1. Netflix raised prices multiple times. Why did customers largely accept these increases?
  2. Calculate the markup price if: variable cost = $15, fixed costs = $450,000, expected sales = 30,000 units, desired markup = 25% on sales.
  3. When is market skimming preferable to market penetration? Give two conditions for each.
  4. Why did Groupon fail to retain business clients? What should they have done differently?
  5. A luxury car brand priced at $95,000 faces a competitor at $85,000. Using EVC pricing logic, how would you defend the $10,000 premium?
  6. Under what conditions does price discrimination work legally and economically?
  7. Explain the experience curve and its pricing implications โ€” including the risks.

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