Setting Price: Part 2 Tutorial

In the Setting Price: Part 1 tutorial we saw how marketers begin the process for setting an initial price for their product. However, for most marketers additional pricing decisions are still needed.

In Part 2 of our Setting Price tutorial we continue our discussion of the 5-Step price setting process by looking at Steps 3 through 5. Our coverage will include different price adjustments marketers make before settling on a final selling price; payment options; and additional issues that affect pricing.

As noted in Part 1, not all marketers will follow this step-by-step approach. In fact, as we will see many marketers may choose to bypass Steps 3 and 4 altogether. However, the majority of marketers will indeed go through all steps, thus marketers should have a good understanding of the options available.

With the first round of pricing decisions now complete, the marketer’s next step is to consider whether there are benefits to making adjustments to the list or published price. For our purposes we will consider two levels of price adjustments – standard and promotional. The first level adjustments are those we label as “standard” since these are consistently part of the marketer’s pricing program and not adjustments that appear only occasionally as part of special promotions (see Step 4: Determine Promotional Pricing).

In most cases standard adjustments are made to reduce the list price in an effort to either stimulate interest in the product or to indirectly pay channel partners for the services they offer when handling the product. In some circumstances the adjustment goes the other way and leads to price increases in order cover additional costs incurred when selling to different markets.

It should be noted that many companies do not make adjustments to their list price, particularly those selling directly to final customers. There are two key reasons for this. First, the product is in high demand and therefore the marketer sees little reason to lower the price. Second, the marketer believes the product holds sufficient value for customers at its current list price and the marketer feels reducing the price may actually lead buyers to question the quality of the product (e.g., "How can they offer all those features for such a low price? Something must be wrong with it."). In such cases holding fast to the list price allows the marketer to maintain some control over the product’s perceived image.

For firms that do make standard price adjustments, options include:

  • Quantity Discounts
  • Trade Allowances
  • Special Segment Pricing
  • Geographic Pricing

Manufacturers who rely on channel partners to distribute their products (e.g., retailers, wholesalers) offer discounts off of list price called trade allowances. These discounts function as an indirect form of payment for a channel member’s work in helping to market the product (e.g., keep product stocked, talk to customers about the product, provide feedback to the manufacturer, etc.).

Essentially the difference between the trade discounted price paid by the reseller and the price the reseller charges its customer will be the reseller’s profit. For example, let’s assume the maker of snack products sells a product to retailers that carries a stated MSRP of (US) $2.95 but offers resellers a trade allowance price of $1.95. If the retailer indeed sells the product for the MSRP, the retailer will realize a 33% markup on selling price ($1.95/(1-.33) = $2.95). Obviously this percentage will be different if the retailer sells the product at a price that is different than the MSRP, but the important point to understand is that marketers must factor in what reseller’s expect to earn when they are setting trade discounts. This amount needs to be sufficient to entice the reseller to agree to handle and possibly promote the product.

This adjustment offers buyers an incentive of lower per-unit pricing as more products are purchased. Most quantity or volume discounts are triggered when a buyer reaches certain purchase levels. For instance, a buyer may pay the list price when they purchase between 1-99 units but receive a 5% discount off the list price when the purchase exceeds 100 units.

Options for offering price adjustments based on quantity ordered include:

  • Discounts at Time of Purchase – The most common quantity discounts exist when a buyer places an order that exceeds a certain minimum level. While quantity discounts are used by marketers to stimulate higher purchase levels, the rational for using these often rests in the cost of product shipment. Shipping costs tend to decrease per item shipped. Why? Think about a large truck carrying product. In most cases the expenses (e.g., truck driver expense, fuel, road tolls, etc.) required to move a truck from one point to another does not radically change as more product is shipped in the truck trailer (i.e., container). In other words, the total shipping cost is only a little higher if 1,000 items (assuming all can fit in a trailer) are carried in the truck compared to hauling just 10 items. Consequently, the transportation cost per item drops as more are ordered thus allowing the supplier to offer lower prices for higher quantity.
  • Discounts on Cumulative Purchases – This method allows the buyer to receive a discount as more products are purchased over time. For instance, if a buyer regularly purchases from a supplier they may see a discount once the buyer has reached predetermined monetary or quantity levels. The key reason to use this adjustment is to create an incentive for buyers to remain loyal and purchase again.

In some industries special classes of customers within a target market are offered pricing that differs from the rest of the market. The main reasons for doing this include: building future demand by appealing to new or younger customers; improving the brand’s image as being sensitive to customer’s needs; and rewarding long time customers with price breaks.

For instance, many companies including movie theaters, fitness facilities and pharmaceutical firms offer lower prices to senior citizens. Some marketers offer non-profit customers lower prices compared to that charged to for-profit firms. Other industries may offer lower prices to students or children.

Another example used by service firms is to offer pricing differences based on convenience and comfort enjoyed by customers when experiencing the service such as seat location at a sporting or entertainment event.