PRICE THE 2ND P OF MARKETING MIX:Price Changes, Initiating Price Increases

<< PRICE THE 2ND P OF MARKETING MIX:Discount and Allowance Pricing, Segmented Pricing

PLACE- THE 3RD P OF MARKETING MIX:Marketing Channel, Channel Behavior >>

Principles of Marketing MGT301

Lesson 27

Lesson overview and learning objectives:

In last Lesson we discussed the different price adjustment strategies. Today we will have discussion

on different price changes that can tale place and customers and companies responses towards

these changes. We will have review of concepts discussed in Lessons regarding Price as well

PRICE THE 2ND P OF MARKETING MIX.

B. Price Changes

After developing their pricing structures and strategies, companies often face situations in which

they must initiate price changes or respond to price changes by competitors.

a. Initiating Price Changes

In some cases, the company may find it desirable to initiate either a price cut or a price increase. In

both cases, it must anticipate possible buyer and competitor reactions.

i. Initiating Price Cuts

Several situations may lead a firm to consider cutting its price. One of the such circumstance is

excess capacity. In this case, the firm needs more business and cannot get it through increased

sales effort, product improvement, or other measures. It may drop its "follow-the-leader

pricing"--charging about the same price as its leading competitor--and aggressively cut prices to

boost sales. But as the airline, construction equipment, fast-food, and other industries have learned

in recent years, cutting prices in an industry loaded with excess capacity may lead to price wars as

competitors try to hold on to market share.

Another situation leading to price changes is falling market share in the face of strong price

competition. Either the company starts with lower costs than its competitors or it cuts prices in the

hope of gaining market share that will further cut costs through larger volume.

ii. Initiating Price Increases

A successful price increase can greatly increase profits. For example, if the company's profit margin

is 3 percent of sales, a 1 percent price increase will increase profits by 33 percent if sales volume is

unaffected. A major factor in price increases is cost inflation. Rising costs squeeze profit margins

and lead companies to pass cost increases on to the customers. Another factor leading to price

increases is excess demand: When a company cannot supply all its customers' needs, it can raise its

prices, ration products to customers, or both.

Companies can increase their prices in a number of ways to keep up with rising costs. Prices can be

raised almost invisibly by dropping discounts and adding higher-priced units to the line. Or prices

can be pushed up openly. In passing price increases on to customers, the company must avoid

being perceived as a price gouger. Companies also need to think of who will bear the brunt of

increased prices

There are some techniques for avoiding this problem. One is to maintain a sense of fairness

surrounding any price increase. Price increases should be supported with a company

communication program telling customers why prices are being increased and customers should be

given advance notice so they can do forward buying or shop around. Making low-visibility price

moves first is also a good technique: Eliminating discounts, increasing minimum order sizes,

curtailing production of low-margin products are some examples. Contracts or bids for long-term

projects should contain escalator clauses based on such factors as increases in recognized national

price indexes. The company sales force should help business customers find ways to economize.

Wherever possible, the company should consider ways to meet higher costs or demand without

raising prices. For example, it can consider more cost-effective ways to produce or distribute its

products. It can shrink the product instead of raising the price, as candy bar manufacturers often

do. It can substitute less expensive ingredients or remove certain product features, packaging, or

129

Principles of Marketing MGT301

services. Or it can "unbundle" its products and services, removing and separately pricing elements

that were formerly part of the offer.

b. Buyer Reactions to Price Changes

Whether the price is raised or lowered, the action will affect buyers, competitors, distributors, and

suppliers and may interest government as well. Customers do not always interpret prices in a

straightforward way. They may view a price cut in several ways. For example, what would you

think if any company suddenly cuts its VCR prices in half? You might think that these VCRs are

about to be replaced by newer models or that they have some fault and are not selling well. You

might think that company is abandoning the VCR business and may not stay in this business long

enough to supply future parts. You might believe that quality has been reduced. Or you might

think that the price will come down even further and that it will pay to wait and see.

Similarly, a price increase, which would normally lower sales, may have some positive meanings for

buyers. What would you think if company mentioned above raised the price of its latest VCR

model? On the one hand, you might think that the item is very "hot" and may be unobtainable

unless you buy it soon. Or you might think that the VCR is an unusually good value.

c. Competitor Reactions to Price Changes

A firm considering a price change has to worry about the reactions of its competitors as well as its

customers. Competitors are most likely to react when the number of firms involved is small, when

the product is uniform, and when the buyers are well informed.

How can the firm anticipate the likely reactions of its competitors? If the firm faces one large

competitor, and if the competitor tends to react in a set way to price changes, that reaction can be

easily anticipated. But if the competitor treats each price change as a fresh challenge and reacts

according to its self-interest, the company will have to figure out just what makes up the

competitor's self-interest at the time.

The problem is complex because, like the customer, the competitor can interpret a company price

cut in many ways. It might think the company is trying to grab a larger market share, that the

company is doing poorly and trying to boost its sales, or that the company wants the whole

industry to cut prices to increase total demand.

When there are several competitors, the company must guess each competitor's likely reaction. If

all competitors behave alike, this amounts to analyzing only a typical competitor. In contrast, if the

competitors do not behave alike--perhaps because of differences in size, market shares, or

policies--then separate analyses are necessary. However, if some competitors will match the price

change, there is good reason to expect that the rest will also match it.

Responding to Price Changes

Here we reverse the question and ask how a firm should respond to a price change by a

competitor. The firm needs to consider several issues: Why did the competitor change the price?

Was it to take more market share, to use excess capacity, to meet changing cost conditions, or to

lead an industry wide price change? Is the price change temporary or permanent? What will happen

to the company's market share and profits, if it does not respond? Are other companies going to

respond? What are the competitor's and other firms' responses to each possible reaction likely to

be?

Besides these issues, the company must make a broader analysis. It has to consider its own

product's stage in the life cycle, the product's importance in the company's product mix, the

intentions and resources of the competitor, and the possible consumer reactions to price changes.

The company cannot always make an extended analysis of its alternatives at the time of a price

change, however. The competitor may have spent much time preparing this decision, but the

company may have to react within hours or days. About the only way to cut down reaction time is

to plan ahead for both possible competitor's price changes and possible responses.

There are several ways a company might assess and respond to a competitor's price cut. Once the

company has determined that the competitor has cut its price and that this price reduction is likely

to harm company sales and profits, it might simply decide to hold its current price and profit

130

Table of Contents: