Pizza Pricing Strategy

Attachments

5
The Marketing Mix: Price
Shoppers in a clothing store with discounted prices.

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Learning Outcomes

After reading this chapter, you should be able to

Give examples of how buyer psychology influences pricing strategy.
Describe four inputs to the strategic planning process for pricing decisions.
Explain why a segmented price strategy is worth considering, despite its complexity.
Explain the main objectives of sales promotions.
Summarize three challenges to developing effective pricing strategies.

Introduction

Musical icon Bruce Springsteen brought his talents to Broadway in 2017, choosing a theater with fewer than 1,000 seats for an event that combined storytelling with an intimate one-man performance featuring the Boss on piano and guitar. Springsteen set the ticket prices at $75 to $850; tickets were distributed through a lottery that required identity verification, with the intent to keep them from being resold by scalpers. But tickets leaked into the open market and could be found on StubHub at prices ranging from $1,200 to $9,999, the New York Times reported. With limited seating and apparently limitless demand, why would the Boss have chosen to price the tickets so much lower than fans were clearly willing to pay? We can’t peer inside his head or heart to know, but New York Times journalist Neil Irwin offered, “One view of the Springsteen approach is that it is economically irrational. But another is that it is part of a long-term relationship between a performer and his fans” (Irwin, 2017, para. 8). Besides a rare theatrical experience, Springsteen has given us a view into the complex world of pricing strategy.

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 seldom a good reason for pricing an offering so low that it does not cover its costs (unless, like Bruce Springsteen, you have other motivations than profit). 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.

“Price” 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 examines the decision process that marketers go through in setting prices, while familiarizing you with the terminology marketers use. You will learn about strategies and tactics that apply to pricing, and about the challenges that make determining a pricing strategy for an organization’s goods and services so complex. By the conclusion of this chapter, you will recognize how Marketing 3.0’s call for more humanity-centric marketing practices influences this P of the marketing mix.

5.1 Pricing Basics

What is a price, exactly? The AMA (2017b) 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” (para. 219). At its simplest, price might be described as what a customer has to give up in order to get what he or she 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.)

The right pricing strategy can lift a brand’s cachet and lock in loyal customers for the long term. The wrong pricing strategy can rob a business of its competitive edge or starve it by failing to generate sufficient revenue to cover costs.

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. Consider tuition for education (yet another name for a price). A school publishes its tuition structure. The institution may 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 course work.

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.

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. See table 5.2 for answers.
Table 5.1: Many ways to say price
Offerings Terms
Sandwich Rent
Credit card Subscription
Lawyer Interest
Trade association Fee
Bus trip Fare
Apartment Dues
Mobile app Price

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.
Table 5.2: Many ways to say price answers
Offerings Terms
Sandwich Price
Credit card Interest
Lawyer Fee
Trade association Dues
Bus trip Fare
Apartment Rent
Mobile app Subscription

Note. Price goes by many names in daily life.
Storefront of Louis Vuitton.

tupungato/iStock Editorial/Getty Images Plus

The brand image a company selects affects the price of its merchandise, since price reinforces brand identity. A luxury offering cannot be bargain priced and still maintain its high-end positioning.
Price and the Marketing Mix

The marketing mix, as you have learned in previous chapters, consists of the four Ps of product, place, price, and promotion. From the marketing orientation, which places customers at the center of all marketing mix decisions, we recognize that pricing strategy must begin with understanding how customers decide what to pay for what they buy. Price can be led or driven by the other four Ps of the marketing mix but cannot be divorced from them.

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 expectations, competitors’ pricing strategies, and the brand image a company has chosen to project, since price reinforces brand identity. A luxury offering like a cruise cannot be priced below a certain amount and maintain its luxury aura, nor can a bargain offering like bulk-pack paper towels be priced above a certain point and still maintain its value positioning. Similarly, customer expectations and 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 shape sellers’ pricing decisions.

The entire purchase situation affects consumers’ perception of value. In the bricks-and-mortar world, 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. Likewise, online shoppers look for ease of navigation and comparison among offerings, clear explanations of shipping and return policies, and customer testimonials to help them form perceptions about price. And of course, many people blend online and bricks-and-mortar shopping behavior concerning price before making a purchase—for example, choosing to avoid shipping charges by having a product delivered for pickup at a nearby store.

Interestingly, consumers are prone to perceive the purchase situation inaccurately and to react to their inaccurate evaluation of the situation. If the brochure for your whale-watching cruise to Alaska depicted whales airborne in gymnastic leaps, and yet as a traveler you only witness a few humps breaking the ocean’s surface, you could feel your cruise was overpriced.

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 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).

For an example, consider a Le Creuset iron skillet. The same product is available through several online retailers, including Williams-Sonoma.com, AllModern.com, CutleryandMore.com, and of course, Amazon.com. Each product listing includes a “suggested price” of $250 to $285 and a “sale price” within a few cents of $200 (Streitfeld, 2016). Thanks to the skillet’s reference price range, the savvy chef knows that $200 is a fair price.

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, and they place a burden on the buyer, as the following examples show. A member of an airline’s frequent flier program considering a switch to another will face an opportunity cost: The new program will bring some additional benefits, but the flier will have to surrender perks of his or her previous program. Implementation may require additional purchases, such as Apple’s iPhone 7, released in 2016, which did not include a headphone jack. Users needed to purchase Lightning or Bluetooth headphones, which were more expensive than traditional earbuds and other headsets that used the traditional 3.5mm connector. A business switching software for its clerical workforce might have to spend on employee training or conversion of existing template documents.

Companies can respond to, but not change, how consumers’ minds work. Buyer psychology—why people buy things—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 U.S. Health Care System

In most areas of our consumer purchasing behavior, we can easily compare prices and rely on reference pricing, signposts, and our estimation of switching costs to make reasoned choices. Cost for health care procedures in the United States, however, has been notoriously difficult to compare. The company FairPrice Healthcare launched with a value proposition to change that, using a social community model and a database that offers health care providers for comparison based on geography, quality, or cost.

View an advertisement for FairPrice Healthcare here:

FairPrice: How We Help You Save 30% on Your Healthcare

According to a company press release, FairPrice Healthcare (2016) is “positioned to battle the cost of healthcare with transparency and fairness” (para. 1).

Have you ever shopped for a medical procedure based on cost?

What challenges do you see for health care providers in the face of this disruptor?
Elasticity of Demand

Customers’ expectations have a profound impact on pricing, as has just been shown. So do the economic concepts of supply and demand. Supply represents the amount of a product sellers make available and demand the amount buyers want to purchase. 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.
Figure 5.1: Supply and demand curves
Supply and demand can achieve a point of equilibrium.
Graph showing supply and demand curves that have a point of equilibrium—where price and quantity are equal.

Copyright © 2007, 2000, 1997, 1987, by Barron’s Educational Series, Inc. Reprinted by arrangement with Publisher.

Other factors in the marketing mix, such as product quality, promotion, and distribution (place), can shift the demand curve, allowing a company to sell more product at the current price, or the same amount of product at a higher price—within reason. Shift too far, and consumer perception of value will falter. Prestige products, such as cosmetics, can demand a higher price because reference pricing tells consumers they have bought “the very best.” But if the price of cosmetics were to rival the price of a person’s weekly groceries, he or she might decide to switch to a cosmetic brand at a lower price point.

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, 2012).

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.

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 premium-priced offerings. Consider bottled water: While many brands are accepted as interchangeable commodities, some consumers are quite willing to pay for the higher priced FIJI, Voss, or Perrier brands.

Demand can fluctuate based on factors other than price, such as seasonality or environmental factors. Fireworks can demand a higher price as the Fourth of July nears, as can roses around Valentine’s Day. Forest fires and floods can destroy crops, causing shortages that affect prices and demand. In some cases prices are governed by price controls, in which the government intervenes in the free market to protect consumers by setting a price ceiling or producers by setting a price floor. Examples include limits on interest rates that protect consumers from payday lenders (a price ceiling) and agricultural supports that keep farmers’ price for commodities above their costs of production (a price floor).

Where the demand for an offering is highly elastic, consumers experience price sensitivity—the degree to which the price of a good or service affects a consumers’ purchasing behavior. Consumers are sensitive about how much they pay and will turn to lower priced substitutes if the original item they wanted is too expensive. Some factors that affect consumers’ price sensitivity include the following:

the number of close substitutes
the cost of switching between products
the price of related goods or services
the degree of necessity of the offering
the percentage of the consumer’s income that the purchase will require
tastes or preferences of consumers
the time available for making the decision to purchase
consumer expectations about whether the price will go up or down
whether the offering is subject to habitual consumption

One or a combination of these factors can shift price sensitivity toward elastic or inelastic in a given market.

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! Marketers must estimate demand and price sensitivity when considering where to set prices. An estimate that misses the mark will hurt revenue.

As has been shown, marketers need to understand the interactivity of pricing strategy with the other Ps 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

Describe the elasticity of demand in the following scenarios. Would you change your plans for a family driving vacation if the price of gas spiked up? How about a designer handbag: If you worked in the New York fashion world, would you pay whatever it took to carry the current “it” accessory? Explain your thinking.

5.2 Strategic Planning for Pricing Decisions

Pricing strategy decisions are 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.

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:

cost to produce the product
target market
environment
differentiation strategy

Marketers apply the strategic planning process (which was discussed in Chapter 2) to pricing just as they do to arrive at strategies for the other areas of the marketing mix. Figure 5.2 shows the four influencing factors of price decisions as inputs to the strategic planning process.
Figure 5.2: Inputs and processes of effective price strategy
Four factors are inputs to the strategic planning process by which marketers arrive at a pricing strategy.
Figure of the factors that contribute to 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.
Input: 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).

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 (somewhere between that floor and ceiling) that will meet their organizational goals, choosing from the following approaches.

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.
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 & Armstrong, 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.

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.

The breakeven analysis depends on four key assumptions:

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
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. Variable costs 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:

Breakeven point (in dollars) = Total fixed cost/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 5.3.
Figure 5.3: Breakeven point
Managers estimate the costs, sales, and price per unit of each offering in their product line to establish a breakeven point.
Graph showing how cost and income impact the breakeven point.

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 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 5.4. With this calculation, both financial managers and marketers have solid data to inform a value-based pricing strategy.
Figure 5.4: Breakeven trade-off between price and sales volume
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.
Line graphs showing difference of breakeven trade-off between price and sales amount.

From Boone, L.E., Kurtz, D.L. Contemporary Marketing 14E. © 2008, 2010 South-Western, a part of Cengage Learning. All rights reserved.

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, 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 and contribute to profit margin (the amount by which revenue from sales exceeds costs), so it must reflect the breakeven point.

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 5.5 illustrates a price waterfall for automobiles sold by General Motors.
Figure 5.5 Price waterfall
The price …

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