Pricing of a product

Chapter 10PricingEls Gijsbrechts and Katia Campo

ObjectivesThis chapter does not have as its aim the provisionof ready-made methods for the assessment ofprice levels. Its objectives are:

1 to indicate the importance and complexity ofprice decisions for marketing managers;

2 to consider what is a ‘price’;

3 to identify the factors internal to the firmthat influence price decisions;

4 to identify the factors external to the firmthat influence price decisions;

5 to discuss pricing strategies and tactics.

1 Introduction

Consider a Belgian couple contemplating a shop-ping trip to London during the Christmas pe-

riod. The cheapest way to cross the Channel wouldbe to take a ticket on the ferry from Oostende to Ramsgate, which would amount to about Bfr.1,500 per person. While they can afford this from abudgetary viewpoint, taking the boat would meanspending about five hours travelling, which wouldmean losing almost half of the ‘available’ week-end to hunt for interesting bargains in the Londonshopping area. Taking the plane would drasticallyreduce travelling time, but the air fare of Bfr. 4,900per person is not overly appealing. Friends recom-mend that they buy a combined ticket from theBelgian Railways and the Channel (regular price:Bfr. 3,465 per person). This seems to be the mostinteresting option, but unfortunately no more regular tickets are available for the morning of the Christmas weekend. The price of a first class-Railway/Channel ticket (Bfr. 6,960 per person, in-cluding a luxury meal and free drinks) is pro-hibitive. Ultimately, the couple decides to travelby Hovercraft, at a rate of Bfr. 2,200 per person.

This example illustrates the complexity of con-sumer choices in the face of a variety of alterna-tives offered at different prices. The mirror imageof this problem is the pricing issue for firms offer-ing the products or services to various types of customers: their pricing problem will be equallymultifaceted and complex.

To introduce the nature of the problem and theissues involved, Section 1 elaborates on the mean-ing of price, and on the importance of price as amarketing-mix instrument.

1.1 The meaning of price‘The price of a product or service is the number ofmonetary units a customer has to pay to receiveone unit of that product or service’ (Simon 1989).This was the traditional definition, but in the1990s a broader interpretation of the price concept became customary. Illustrative of thisbroader view is Hutt and Speh’s observation that‘the cost of an industrial good includes muchmore than the seller’s price’ (Hutt and Speh 1998:441).

This broader interpretation extends the ‘tradi-tional’ price notion along three dimensions. First,

it recognizes the possible discrepancy between ob-jective and perceived prices. As will be documentedin Section 4.1.2, it is unrealistic to assume that all customers have complete information onamounts to be paid for market offerings, and psy-chological processes may affect how price infor-mation is assimilated by customers. Secondly,price need not be specified exclusively in mone-tary terms at the time the product is acquired.Product usage may entail additional costs of re-pair, maintenance, and energy consumption thatshould be accounted for. Also, price in a generalsense encompasses non-monetary efforts of prod-uct acquisition. A typical example in consumermarkets is ‘time costs’ associated with alternativeofferings as a result of travel, shopping, waiting,search, and transaction time involved. To the cou-ple ready to engage in the London shopping adventure, the time needed to reach their destina-tion is of crucial importance. In industrial markets, efforts related to installation, transpor-tation, order handling, and inventory-carrying represent examples of non-monetary efforts.Thirdly, price encompasses not only an ‘effort’ but also a ‘risk’ component. Risk associated with product adoption may be functional, such as therisk of product failure or of poor technical and delivery support. It may also be social or psycho-logical in nature, an example being the risk of sig-nalling low social status when driving around in aLada. These ‘recent’ views on pricing seem to reit-erate Adam Smith’s statement in The Wealth of Na-tions (1776) that ‘The real price of everything is thetoil and trouble of acquiring it’ (cited in Keegan1995), complemented with the perceived effortand risk associated with product use. A similarpoint of view is expressed in Zeithaml’s (1988)price definition: ‘From the consumer’s point ofview, price is what is given up or sacrificed to ob-tain a product.’

Recognizing the broad implications of pricing is crucial to managers facing the pricing decision.First, decision-makers have to account for even-tual disparities between real and perceived prices in targeted customer segments. Also, set-ting prices may not be restricted to determiningthe number of monetary units to be paid for one unit of the product at the time of purchase. It may encompass the specification of ‘purchaseand use conditions’ associated with monetaryprice, over the product’s life cycle. In brief, themultidimensional view on prices leads to therecognition that complex pricing schemes may be

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needed, including a ‘system’ of prices for differ-ent types of customers, product packages, andtime periods. This observation is the essence ofstrategic pricing.

1.2 The importance of priceWhile the importance of price as a marketing-mix instrument went unquestioned for severaldecades, the 1990s witnessed an even stronger in-terest in pricing issues, putting price at the fore-front of all marketing actions. Statements like‘Pricing is the moment of truth—all marketingcomes to focus in the pricing decision’ (Corey,cited in Nagle and Holden 1995) are illustrative ofthis point of view. Surveys indicate that US as wellas West European companies rank pricing as moreimportant than other marketing-mix elements(Phillips et al. 1994; Nagle and Holden 1995).

Price distinguishes itself from other marketing-mix instruments in that it captures some of thevalue created by the firms’ other marketing activ-ities by generating ‘cash’. As Nagle and Holden(1995) put it: ‘If effective product development,promotion, and distribution sow the seeds of busi-ness success, effective pricing is the harvest.’Other typical characteristics of price are its flexibil-ity (it takes relatively little time to change it), itsspeed of effect (price yields fast reactions from cus-tomers and competitors), and the force and magni-tude of the reactions it entails. These propertieshave made price a particularly relevant weapon intimes of increased competition, fast technologicalprogress and proliferation of new products, andchanging economic and legal conditions. Yet,while price may be crucial in coping with these sit-uations, few managers to date know how to priceeffectively. The situation is well described by Winkler (1990: 18), when he states: ‘Price, Product,Promotion. The greatest of them is Price. It is alsothe least talked about and the least understood.Correct pricing decisions can be a matter of com-mercial life and death. Yet companies often fail todevelop coherent pricing strategies, and too oftenmarketers find themselves at loggerheads with financial colleagues over what price should be.’

The purpose of this chapter is to uncover basicprinciples underlying prices and pricing. Likemost marketing decisions, pricing is an art butalso a science. Given the complex and multi-faceted nature of prices, and the importance ofprice as a marketing instrument, a systematic ap-proach to ‘strategic’ pricing is called for.

2 Strategic pricing

Pricing strategies have to support the firm’s ob-jectives and overall strategy. Prices obviously

affect revenue per unit directly, but the price isalso a component of the marketing mix and there-fore impacts on overall sales via its contribution tothe consumers’ perception of the product’s image.It follows that decisions about prices have a signi-ficant impact on the company’s success.

2.1 The notion of price boundariesAs suggested in the introduction to this chapter,numerous factors affect the ‘appropriateness’ ofprice decisions, and a company may have to develop pricing schemes adapted to a variety ofsituations and market segments simultaneously.This calls for a systematic and well-planned ap-proach to pricing. At the same time, given themultitude of influencing factors, it may be hard toidentify the ‘best’ price for a given product. More-over, even if it were possible to determine an ‘op-timal’ price in each situation, such a price or set ofprices may not be feasible to implement becauseof its complexity, its non-compliance with legalconstraints, or the costliness of administration.These observations place the ‘systematic’ ap-proach to pricing developed in this chapter in theproper perspective. Instead of pursuing the bestprice level to be implemented, one may simply at-tempt to delineate a range of acceptable price lev-els within which the ultimate price will besituated. Even managers with a ‘back-of-the-enve-lope’ approach to pricing have some lower andupper bound on price in mind. The purpose of the‘systematic’ approach outlined below is to shed more light on the factors that structurally affect the level of the minimal and maximal ac-ceptable prices, and, given information on thesefactors, to assist managers in narrowing down thefeasible price range in their particular situation.The systematic approach thus provides managerswith a more reasoned and complete picture ofavailable pricing options depending on the cir-cumstances, and helps them select one or some of these options in view of their priorities or trade-offs.

It is important to note at the outset that strate-gic pricing is not a ‘one-time’ exercise. The sys-

214 els gijsbrechts and katia campo

tematic approach allows managers gradually toimprove their picture of acceptable prices in agiven situation, without having to go ‘all the way’from the start.

2.2 A systematic approach topricingFig. 10.1 outlines a systematic approach to pricing.As can be seen from this figure, pricing en-compasses a process with two main stages: an-alysis of the pricing environment, and pricedetermination. A prerequisite for effective pricingis knowledge of the internal (company) environ-ment, where information on overall objectives,strategies, and costs, but also on ‘value-creating’marketing-mix activities such as product, com-munication, and distribution, is crucial. Togetherwith characteristics of the external environment(customers, competitors, channel members, andother publics like the government), they shape the possibilities for effective pricing available to the company. Price determination, then, com-prises the selection of pricing objectives, and thechoice of a pricing strategy providing long-termsupport for these objectives. This strategy needs tobe translated into concrete price structures and levels, and supplemented with short-term-oriented, tactical price manipulations. As sug-gested earlier, pricing is far from a strictly sequen-tial, one-time process that managers go through.Instead, managers may find it fruitful to repeatthe stages, gathering supplementary and updatedinformation as they proceed through the stagesrepeatedly.

The remainder of the chapter is organizedaround the pricing process depicted in Fig. 10.1.Section 3 concentrates on internal factors affect-ing pricing. Section 4 discusses major external influences. Given the basic picture obtained from environmental analysis, Section 5 elaborateson the company’s pricing objectives. These form a crucial input to the selection of an appropriatepricing strategy, a systematic overview of which is given in Section 6. Section 7 subsequently focuses on the assessment of price structures and levels, and tactical price decisions are dealt with in Section 8. Section 9 illustrates some of these principles in a case study. Section 10, finally, provides a summary of the discussion andconclusions.

3 Internal factorsaffecting pricing3.1 Company objectives andstrategiesAn essential ingredient of effective prices is theirconsistency with company objectives and overallmarketing strategy. Company objectives are ‘gen-eral aspirations toward which all activities in thefirm, not only pricing, are directed’ (Nagle andHolden 1995: 10). The realization of company objectives necessitates the development of anoverall marketing strategy. To be effective and effi-cient, the company’s pricing decisions must fitinto this strategy, and be in line with decisions on other marketing-mix elements. Also, pricesshould not be set as an ‘afterthought’. Reflectionson appropriate prices should occur at the time theproduct, communication, and distribution are

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conceived, because the different instruments ofthe mix have a ‘synergetic’ influence on the mar-ket. There is ample evidence that the impact ofpricing strategies and structures depends on thecompanies’ communication and distribution ap-proach and on the product’s characteristics.

Various sources highlight the impact of commu-nication strategies on customer price sensitivity.The debate centres around the question whetheradvertising increases or reduces customers’ atten-tion to price. In a special Marketing Science issue onempirical generalizations in marketing, Kaul andWittink (1995) conclude that an increase in non-price advertising leads to lower price sensitivityamong consumers. Conversely, increased price ad-vertising leads to higher price sensitivity. Alongsimilar lines, it is well documented that featureadvertising or point of purchase (PoP) support sig-nificantly increase the impact of price deals (seee.g. Blattberg et al. 1995). Distribution and price deci-sions may equally interact in a variety of ways. Toillustrate: the service and functions provided bydistribution outlets affect what prices customersfind acceptable, as do the outlet’s image, ambient,and design factors (see e.g. Grewal and Baker1994). Perhaps the most obvious interactions arethose between price and product characteristics suchas product quality. Not only does quality affect thecustomers’ willingness to pay and price sensitiv-ity; in a number of product categories, price mayserve as a quality indicator (see Section 4.1.2).

Some of these issues will be taken up againbelow. The observation to be made at this point isthat managers should be aware of marketing-mixinteractions, and exploit them through integrateddecisions on communication, distribution, prod-uct, and price. According to Nagle and Holden(1995), the failure to do so is one of the majorsources of ineffective pricing.

3.2 CostsCosts have traditionally played a major role inpricing decisions. They constitute a basic ingredi-ent for setting a price floor or lower boundary onacceptable prices. Yet, while costs are an essentialingredient to pricing, their role in the pricingprocess can be very complex. Costs indeed havemany faces, and can be classified along differentdimensions.

A first dimension concerns the degree to whichcosts can be directly attributed to specific prod-

INTERNAL ENVIRONMENT:company objectives,strategies, costs

EXTERNAL ENVIRONMENT:customerscompetitorschannel environmentlegal environment

PRICE DETERMINATION

Pricing objectives

Pricing strategy

Price structure and level

Price tactics

Figure 10.1 Analysis of the environment

Sources: Morris and Calantone (1990); Nagle and Holden(1995).

ucts. Hutt and Speh (1998) distinguish between direct traceable, indirect traceable, and generalcosts. Direct traceable costs can be immediately associated with individual products. An exampleis the cost of raw materials. Indirect traceable costsare not directly linked to, but can with some effortbe traced back to, individual products. The cost offilling shelves is illustrative of this type. Generalcosts, finally, cannot be linked to specific prod-ucts. A typical example is administrative overheadcosts. Assessing direct traceable costs, and at-tributing indirect traceable costs, are importantfor pricing.

Equally crucial is the distinction between vari-able and fixed costs. Which of these componentsshould enter the pricing decision depends on thecompany’s objective. For profit-maximizing com-panies, fixed cost may not (immediately) affect optimal prices. Yet, for not-for-profit companiesmaximizing sales or participation subject to adeficit constraint, fixed cost may have a major effect on feasible outcomes. The company’s timehorizon also has a fundamental impact on thecosts to be considered. Whether costs are fixed orvariable depends on the time frame adopted bythe company. Also, forward-looking companiesmay forgo covering fixed costs in view of futurepossibilities.

This leads us to the discussion of cost dynamics.Short-term costs may differ from long-term costlevels as a result of changes in the scale of com-pany operations, or thanks to accumulated experi-ence. Economies of scale arise if the cost per unitdecreases with the output level in a given period.This could be the result of the facility to share cor-porate resources across products, the use of moreefficient (large-scale) production facilities, longproduction runs, access to volume discounts inpurchases, or shipment in full carload or truck-load lots (Monroe 1990). Experience effects are a sec-ond major source of declining production (andpossibly other) costs. As cumulative productionquantity increases, manufacturing procedures be-come more efficient (‘learning by doing’, techno-logical improvements), allowing the production ofsimilar output levels at lower unit cost over time.The reduction in costs with accumulated experi-ence is usually represented by means of an experi-ence curve (see Fig. 10.2), displaying unit costs as afunction of accumulated production experience(approximated by cumulative production vol-ume). Though experience effects are potentiallyimportant, they are not obtained ‘automatically’.


A thorough effort may be needed to exploit thebenefits of experience. This is especially true in aninternational setting, where experience effectsare conditional upon an efficient transfer of skillsand knowledge between strategic business units(SBUs) throughout the world (Phillips et al. 1994).

A full appreciation of costs requires attentionnot just to production activities, but also to themultitude of functions to be performed at variousstages in the company and channel. Such addi-tional functions may be transportation (see In-sert), assistance in product use, and maintenance.Attention to these functions is particularly rele-vant in international marketing, where produc-tion cost typically represents only one part of the total cost. Keegan (1995: 514) refers to this asthe problem of ‘price escalation’ in internationalmarketing: product prices (costs) may substan-tially increase as transportation costs (includinginsurance, special packaging, and warehousingcosts), duties, and distribution margins are added

Figure 10.2 Experience curve

cumulative production volume

unit

cos

ts

80

60

40

20

00 200 400 600 800 1000 1200

Why a shirt costing $100 in Alaska will cost$190 in Paris

An OECD study of international parcel delivery foundthat it costs $90 more to send a shirt from New Yorkto Paris than from New York to Anchorage, Alaska.Given that the shipping distances are similar, this issurprising, but the price difference reflects costs ofcustoms clearance and differences in import dutiesand national taxes.

to factory prices. Companies engaging in interna-tional activities will have to monitor those costsclosely, and attempt to reduce them by offshoresourcing or by regular audits of the distributionstructure. An illustration of international price escalation is given in Table 10.1. As the table suggests, retail prices abroad can easily amount tothree times national ex-factory prices.

Last but not least, in trading off different pricingalternatives, the cost of implementing these alter-native pricing schemes should come into play. Asindicated below, the cost of administering and im-plementing a complex pricing programme may beprohibitive, and may induce managers to settle forless involved or more easily controllable pricingoptions.

As argued above, costs are related to pricefloors: they typically set a lower bound on prices.The contribution margin for a product equals itsprice minus its unit variable cost: if negative, sell-ing the product at that price leads to a loss; if positive, at least part of the fixed cost can be re-covered. While this principle seems utterly sim-ple, the foregoing discussion illustrates that thedetermination and quantification of all relevantcosts may be far from evident. The notion of costsas a ‘price floor’ is ‘blurred’ by product inter-

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dependencies, cost dynamics, cost allocation overchannel members and company subsidiaries, andthe pursuit of multiple company objectives. Yet,knowledge of basic cost components remains acrucial input to the pricing decision, and compan-ies should strive for a complete picture of variouscost issues.

4 External influences onprice

As well as factors internal to the firm, there aremany factors external to the firm that must be

taken into account when prices are set. It is usefulto consider these in four groups—first the charac-teristics of the customers themselves and thenthree aspects of the environment within whichthe firm operates: the competitive, the channel,and the legal environments.

4.1 Customer characteristics

4.1.1 Price–volume relationship

A core issue in pricing is the impact of price on demand and sales volume. Following classical economic theory, the typical demand function isnegatively sloped, indicating that the number ofunits sold is inversely related to price. Thestrength of the relationship between demandedvolume and price—the customers’ price sensitiv-ity—is usually measured by the price elasticity.The price elasticity is the relative change in de-mand (sales) resulting from a relative change inthe unit price of the product. A price elasticity of -2, for instance, indicates that a 1 per cent price increase would reduce the sales volume by 2 percent of its current value. Price elasticities are gen-erally negative, but their value and even their signstrongly depend on product and market character-istics. In a meta-analysis relating changes in aproduct’s regular price to changes in demand(sales or market share), Tellis (1988: 337) foundelasticities for a diversity of consumer products torange between approximately -10 and +2.5, withan average value of -1.76. Similar ‘average’ elastic-ity values have been reported in other meta-studies and reviews. While there is some consis-tency in these ‘average’ outcomes, empiricallymeasured elasticities cover a wide range of values.

Table 10.1 Example of price escalation ininternational markets

Cost factors Domestic Export market market

1. Manufacturer’s price 100 1002. Transportation cost domestic 10

market3. Shipment, insurance, 25

packaging and warehousing costs for exported product

4. Import tariff (20% on landed 25cost, i.e. on 1 + 3)

5. Importer’s margin (10% on 15cost, e.g. on 4)

6. Wholesaler’s margin (20% on 33cost, i.e. on 5)

7. Retailer margin (33% on 36 65(1 + 2) or 6)

8. VAT (19% on 7) 28 50

Price to end-user 174 313

Several reasons can be brought forward for this diversity.

First, measured price sensitivities depend onhow ‘demand’ is quantified: market-share changesin response to price are typically larger than saleschanges. Price sensitivities also vary with the unitof analysis considered (e.g. item, brand, or cate-gory); lower levels of aggregation usually entailstronger price responsiveness.

Secondly, the ‘nature’ of the price change af-fects elasticity outcomes. Market reactions to a‘regular’ price change may be different from response to temporary promotional price cuts.While evidence on the issue is conflicting, thereare at least a number of studies reporting pricepromotion elasticities to be more negative (Blattberg and Neslin 1989). The impact of tem-porary price offers is further commented upon in Section 8.

Thirdly, as suggested in Section 3.1, the level ofprice elasticity depends on distribution and commu-nication, but especially on product characteristics.Products or services with a unique brand value aresaid to be less sensitive to price changes (in-creases). An example would be the limited pricesensitivity within the target segment for Ferraricars, or Rolex watches. Situations where pricecomparisons are complex also imply less pro-nounced reactions to price changes. Examples areinsurance packages, and pharmaceutical productsthat come in various forms and require differentdaily dosages and usage periods. Price elasticitiesare typically less negative (and occasionally evenpositive) in categories where price serves as a qual-ity cue. This is, for instance, the case for beautycreams. Products that involve shared payment exhibit lower price sensitivity. Examples are tax-deductible gifts, or managers’ participation in educational programmes partly paid for by theemployer. Customers seem less reactive to pricechanges and willing to pay higher prices for prod-ucts that they have invested in previously. Typicalcases are maintenance products for expensiveitems, such as high-tech. machinery or leathercouches. Similarly, products that are used ‘in com-bination’ with others entail less price sensitivity.An example is the choice of wine in a restaurantaccompanying a meal: consumers tend to have ahigher willingness to pay for wine in those cir-cumstances, compared to in a bar, where only thedrink is consumed. Factors that enhance respon-siveness to prices are the product’s importance inthe total budget (for example, phone conversa-


tions versus paper clips), its storability (for ex-ample, bulky or perishable items), and the avail-ability of substitute products (Nagle and Holden1995).

Finally, price elasticity changes over the productlife cycle (PLC). The traditional view is that pricesensitivity increases as the product evolves overthe life cycle, owing to more intense competitionand better customer knowledge. Recent evidence(Simon 1989; Parker and Neelamegham 1997) sug-gests that in many categories price sensitivity firstdeclines as the product moves from the introduc-tion to the growth and maturity stage, and thenincreases in the decline phase of the PLC.

� ‘Gross margins tend to decline in the saturation period stage, since prices

begin to soften as competitors struggle to obtainmarket share in a saturated market.’ (Chapter14, p. 332)

So far, we have considered the aggregate (market-level) relationship between demand andprice, and discussed general factors affecting thestrength and the direction of the association.While these are relevant as a first step, managersdetermined to utilize pricing strategies to theirfull potential have to look beyond aggregate de-mand functions. A first reason is that the overallprice–volume relationship reflects the reaction ofa ‘typical’ or average consumer, but conceals con-siderable variation in individual responses. Sec-ondly, the demand function is a ‘black box’ thatmeasures how price is ultimately translated intosales, but forgoes all intermediate steps. Morespecifically, it yields little information on howprice is perceived and processed. Recent researchpoints to the importance of insights into individ-ual customers’ price reaction processes as a basisfor strategic and tactical price decisions. Sincethese processes may be different for individualconsumers and for industrial customers, we elabo-rate on them separately.

4.1.2 Individual consumers

The traditional microeconomic picture of a con-sumer who correctly registers all prices and pricechanges, and acts ‘rationally’ upon them so as tomaximize his utility, has been falsified for quitesome time. A myriad of studies on consumer priceknowledge, perception, and evaluation uncoverthat consumers’ reactions to price are much less

stylized and homogeneous than suggested by traditional microeconomics. Understanding theimplications of pricing, therefore, requires consid-eration not only of factual prices and their salesoutcomes, but also of how these prices are per-ceived and evaluated.

Several studies reveal that, for frequently pur-chased consumer goods, consumers have lowawareness of specific item prices. In 1990 Dicksonand Sawyer investigated shoppers’ price recall im-mediately after they had selected an item from theshelf. The researchers found that about 20 percent of the shoppers had no idea of the price of theitem just chosen, and only 55 per cent of the re-spondents provided an estimate within 5 per centof the exact price. Price knowledge is low not onlyfor regular, but also for promotional prices: abouthalf of the shoppers in the study could not even tell whether the product just bought was onprice promotion. Similar results were obtained byother researchers. Reasons for this limited priceknowledge could be the complexity of price in-formation, the time pressure, the limited price differences between items in supermarket cate-gories, and the typically low involvement levels inthose categories.

The issue of ‘price recall’ and of limited absoluteprice knowledge is also related to consumers’ priceencoding. Consumers may internally ‘register’ orencode prices in different ways. They may storeabsolute prices, or concentrate on relativeprices—whether the product is cheaper or moreexpensive than other products in the category.Whether consumers encode absolute or relativeprice information is related to their processinggoals. If the information is to be used immedi-ately, and for choice rather than quantity deci-sions, relative price storage will do. Especially insuch situations, managers should worry less aboutabsolute prices, but find it crucial not to be moreexpensive than relevant competitors.

So far, we have concentrated on price percep-tion of items or brands. Retailers may, in addition,be concerned with the price image of their storeor chain as a whole. As price is deemed an impor-tant element in consumer store choice, and influ-ences store traffic and performance, store priceimage is a hot topic on the retailer’s agenda. Giventhat a typical supermarket carries about 20,000stock-keeping units (SKUs) it is impossible for con-sumers to process complete price information. In-stead, they form store price images on the basis ofnon-price cues such as the store’s atmosphere and

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design, and on the basis of price information for a subset of products (see e.g. Grewal and Baker1994). Product categories likely to contribute tostore price image are categories with large salesrevenues, high visibility, and little product differ-entiation. Examples of such categories are milkand coke or, in the case of DIY stores, an electricdrill.

But consumers do not limit their effort to priceencoding. Especially for frequently purchasedconsumer goods, they also use simple decisionrules and procedures for price evaluation. Most con-sumers have a range of acceptable prices, with anupper and a lower price limit (Lichtenstein et al. 1993).The upper limit, commonly referred to as the‘reservation price’, corresponds to the maximumamount consumers are able or willing to spend onthe product. This maximum level exists becauseprice acts as a ‘constraint’—if the price is too high,the consumer cannot afford the product withinthe confines of his budget, or prefers to spend his money on other products (opportunity cost).Above the upper limit, therefore, no purchase willbe made. The lower limit of the consumers’ pricerange originates from the role of price as a ‘qualityindicator’ or an ‘asset’. Below this limit, quality isconsidered suspect, or the product not acceptablebecause it may signal low social status. Studies onthe association between price and perceived qual-ity show that price may be used as a quality cue,depending on the availability of other cues. Con-sumer characteristics such as risk proneness,product interest, familiarity with the product, anddemographics also affect whether price is used asa quality signal. The range of acceptable prices is acrucial starting point for consumer purchase deci-sions. Products with prices out of this range arediscarded as alternatives for adoption. Knowledgeof consumers’ acceptable price ranges is, there-fore, important for managers to assess their ownprice boundaries.

The range of acceptable prices acts as a prelim-inary ‘device’ to rule out a number of products.Next, prices for products within the range arecompared with the consumer’s ‘reference price’.This reference price is a standard or benchmarkfor evaluation. Actual prices will be perceivedmore favourably when they are lower or equal to the reference price than when they exceed reference prices. Several empirical studies have demonstrated that the difference betweenreference and actual prices (the ‘transaction utility’ (Thaler 1985) ) can play an important role

theory’ (see e.g. Thaler 1985), consumers judge aloss as more painful than they judge a gain ofequal size pleasurable. In our example, the secondoffer would give people a stronger incentive toarrange for their own transportation. Dependingon the purchase option they want to stimulate,managers should thus frame their offers in a dif-ferent manner. A similar phenomenon is that ofasymmetric reactions to upward or downwardprice changes. Price increases (losses) often evokelarger changes in demand than equally sized pricereductions (gains). In planning their price struc-tures, managers should anticipate and ‘exploit’these differential reactions. Finally, framing af-fects the consumers’ immediate reaction to pricechanges, but also whether reference prices will beadjusted. Managers should be sensitive to thisissue in setting prices.

So far, we have concentrated on general aspectsof consumer reactions to prices. An extensiverange of studies documents that consumers areheterogeneous in their levels of price search, knowl-edge, and recall accuracy. Consumers also differ inthe location of their acceptable price range: theyhave different upper and lower price limits, differ-ent reference price levels, and different latitudesof acceptance around the reference price. A widerange of factors may explain these differences.Economic factors, such as perceived price differ-ences, budget restrictions, and income levels, area first source of heterogeneity. Search and transac-tion costs stemming from time constraints, mobil-ity restrictions, age, household composition, andlocation, also affect consumer price processingand evaluation. Thirdly, human-capital characteris-tics such as time-management skills and basicknowledge may come into play. Fourthly, the levelof price processing depends on the expected psycho-social returns from price information collection andproduct adoption, which are often related to cul-ture and peer group. Finally, consumer traits like va-riety-seeking versus loyalty cause consumers toreact differently to prices. As will be argued in sub-sequent sections, recognition of consumer hetero-geneity is crucial for effective pricing: managersshould exploit these differences in the develop-ment of pricing strategies and tactics.

4.1.3 Industrial customers

The price sensitivity of industrial customers ismuch less researched and documented than thatof individual consumers.

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The general product-related determinants ofprice sensitivity mentioned in Section 4.1.1 alsoapply to industrial customers, but there may bedifferences in the relative impact of these deter-minants. Overall, industrial decision-making is be-lieved to be more ‘rational’ and based on morecomplete information. Price would, for example,be less often used as a quality signal in industrialsettings. Other factors such as the importance inthe total cost of the end product and the im-portance in the functioning of the end product aredeemed more important determinants of theprice sensitivity of industrial buyers than of individual consumers. It is also believed that, in a number of industrial exchange settings, cus-tomers are not simply price-takers, but have somenegotiation power and actively participate in theprice-determination process. This is rarely thecase in consumer marketing. Apart from thesegeneral tendencies, it should be recognized that,even more than consumer-price perception andprocessing, industrial buyers’ reactions to pricesare heterogeneous. The importance of price surelydepends on the sector considered. Price has typi-cally become less crucial in supplier–manufac-turer relationships, where long-term partnership,relationship marketing, and single sourcing arenow key elements. In contrast, price has becomethe more dominant issue in manufacturer–re-tailer interactions—a shift linked to the realloca-tion of power in classical distribution channels.Within sectors, the role of price in the purchasingprocess may differ, depending on the type of prod-uct, the repetitive nature of the purchase, and theparties involved (buying group versus individualprofessional purchaser). Even within products andproduct types, heterogeneous reactions to pricesmay prevail. Large-sized customers are, for exam-ple, often particularly sensitive to prices. As inconsumer markets, the industrial marketer, must,therefore carefully analyse differences in priceperception and evaluation in various customersegments, and consider the use of strategies capturing the opportunities set out by these differences.

In brief, insights into price reactions of cus-tomers are crucial to the assessment of priceboundaries. While the budgetary implications ofprice for consumers put pressure on the com-pany’s maximum price level, price–quality associ-ations and the importance of price as a qualitysignal contribute to a lower limit on companyprices. As has become apparent from the previous

discussion, both roles of price (as a constraint, oras an asset) are highly product, customer, and situation dependent; and consequently so will bethe company’s price boundaries and ultimatelychosen price structures and levels.

4.2 Competitive environmentIn determining prices, the competitive environ-ment should explicitly be accounted for. The levelof demand associated with a given company price strongly depends on prevailing competitiveprices. Moreover, in a dynamic setting, not onlymust current prices of competitors be taken intoaccount, but so should competitive reactions.Competitive retaliation may attenuate pricing effects. It could even provoke price wars whereprices of all market players are systematically re-duced, possibly to unprofitable levels. In the late1990s increased competition in the airline markethas systematically driven down air fares for allmajor market players. Careful analysis of competi-tion is, therefore, a prerequisite for effective pric-ing. Competitors may react with an adaptation ofprice or other marketing instruments: price ac-tions may stimulate a price response from some,and a non-price response from others (Guiltinanand Gundlach 1996). Both price and non-price re-actions of current market players affect the fea-sibility of a company’s own pricing policy, andshould be monitored. In addition, the company’spricing activity may attract new competitors ordrive current players out of the market; atten-tion to potential and future competition is thusneeded.

Competitive price reactions to price changesvary from passive (no reaction), through matching(following price changes), to retaliatory (cuttingprices below competitive levels). Leeflang and Wittink (1996), for example, found empirical sup-port for competitive ‘overreaction’ to promotionalprice changes, whereas other studies provided evi-dence of less pronounced competitive reactions(see e.g. Brodie et al. 1996). One reason for the divergent findings is that competitive behaviourdepends on the nature of the competitive environ-ment: the market structure, the level of marketconcentration, and the existence of competitiveadvantages.

Market structure is defined by the number of buy-ers, the number of sellers, and the degree of prod-uct differentiation. Less buyers, more sellers, andless product differentiation lead to higher price


sensitivity of consumers, and to a higher probabil-ity of competitive reactions to own prices andprice changes. Apart from the overall marketstructure, the level of concentration (distribution of market shares across competitors) affects thelikelihood and nature of competitive reactions.Competitors with larger shares and more vestedinterests in the market often react more stronglyto price adjustments. Thirdly, the presence andnature of competitive advantages influence the ex-tent to which a company can maintain pricesbelow or above competitive levels, as well as thetype and outcome of competitive reactions. Costadvantages occur when the product can be pro-duced or distributed at a lower unit cost than competitive products thanks to superior skills, re-sources, experience effects, and economies ofscale. Unique product value advantages are valid ifthe company product has tangible or intangiblecharacteristics that differentiate it from those ofcompetitors and are valued by customers. Com-petitors’ pricing strategies are inspired by theirstrategic positioning. If their competitive advan-tage is based on product features, prices abovecompetition can be justified; if it is based on costonly, maintaining a low price is essential. Also,competitors tend to respond to actions of othermarket players by using those marketing vari-ables that are their ‘best weapons’ (Guiltinan andGundlach 1996). Companies relying on product-based advantages typically show little price reac-tion and are less likely to engage in price wars.Companies whose competitive strength is basedon cost are bound to react with a price change,may engage in price war, and are more likely tosurvive it. The sustainability of competitive advan-tages is a crucial issue, which severely impacts onprices and pricing strategies. At the end of thetwentieth century, for instance, retailers had ahard time finding sustainable competitive advan-tages, which led to more intense price competi-tion and smaller margins.

� ‘In any case, as differentiation governs the price sensitivity of an offering, it is

both a precondition and a source of whateverfreedom the seller has in setting prices. The lessdifferentiated the offering is, the less latitudethe seller has to set prices.’ (Chapter 15, p. 363)

From the foregoing discussion, it becomes clearthat anticipating competitive reactions to ownprices is crucial for assessing price boundaries

and, ultimately, price determination. The threatof competitive reactions and price wars will putupward pressure on lower price boundaries. Atthe same time, the risk of losing share to competi-tors, and of attracting new players to the mar-ket, pushes prices downward. While crucial forsound decision-making, predicting competitivereactions is utterly difficult. As Guiltinan andGundlach (1996: 87) put it: ‘Competitive conjectur-ing is (understandably) mediocre or erroneous inmany settings.’ Anticipation of competitive movesis often based on public statements, signals, roughestimates, and previous reactions. In an inter-national setting, predicting competitive reactionsis even more difficult, especially for companieswith a multi-domestic strategy (Phillips et al. 1994).

4.3 Channel environmentMost companies operate within a marketing chan-nel: they obtain products, components, and/ormaterials from suppliers; and many pass theirproducts onto intermediaries before they reachthe end-users. The characteristics of the channel,and the (associated) reactions of channel mem-bers, strongly affect the nature of the pricing problem as well as the effectiveness of alternativepricing strategies, structures, and instruments.

Marketing channels may exhibit different struc-tures. The channel structure relates to the flow ofproducts from the manufacturer to the end-user:it depends on the number of levels in the channel,and on the number of players at each level. Chan-nels vary from short (e.g. two levels only: the manufacturer sells directly to the end-user) to verylong, and they may have different lengths evenwithin industries. For fast-moving consumergoods (FMCGs), typical channels consist of threelevels: manufacturer, retailer, and end-user. In in-ternational marketing, it is not uncommon tohave as many as five levels. The nature of competitionat given channel levels also varies: from no com-petition (only one member, or exclusive distribu-tion) to many competing middlemen. Channelscan be further characterized by their level of ver-tical integration, which can range from completeintegration (wholly owned subsidiaries), throughfranchising, to the presence of independent mid-dlemen. Finally, channels differ in the allocation ofleadership across levels, where the power may restprimarily with manufacturers, retailers, or evenend-users.

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The impact of channel characteristics on com-pany price decisions has become a topic of greatconcern. Depending on the channel structure, thelevel of vertical integration, and the allocation ofpower, a company may have to set prices for dif-ferent channel levels simultaneously. An exampleof such ‘multi-tiered’ pricing is a manufacturer de-ciding on the price he will charge to the retailer,and at the same time formulating a ‘suggested’ re-tail price for end-consumers. Channel characteris-tics also determine which price structures andinstruments are appropriate, as further illustratedin Sections 6, 7, and 8. The location of powerwithin the channel determines who initiates pricechanges, as well as who reacts. In a leader–follower framework, one channel member (for ex-ample, manufacturer or retailer) decides on priceadjustments, and channel members at other lev-els follow. Alternatively, price decisions at differ-ent channel levels may be set in coordination. Justas in the case of competitive interactions, channelmembers from a different level may react to pricechanges with changes in other marketing-mix in-struments under their control. For instance, retail-ers may adapt their service level as a function ofthe margins granted to them by manufacturers. Fi-nally, price actions at one level have an influenceon the number of players and intensity of compe-tition at other levels. This often confronts man-agers facing price decisions with the trade-offbetween availability and power of middlemen.

While channel interdependencies bear some re-semblance to competitive interactions, their im-pact on pricing is more involved and outspoken.Channel participants at different levels experi-ence rivalry (allocation of profit within the chan-nel), but also perform complementary functions,possess complementary information, and havemore shared interests (allocation of profit to thechannel) than is true for competitors at the samelevel. Also, even when the degree of vertical inte-gration is low and channel members are formallyindependent, parties at different channel levelsare likely to engage in negotiations or look forsome form of contractual arrangements. This israrely true for competitors, where such agree-ments are forbidden by law (see also Section 4.4).

The mid-1990s witnessed an increased attentionto the channel implications of pricing strategies. Itis now recognized that effective pricing requiresconsideration of channel interactions and dynam-ics. Academics as well as practitioners attempt tointegrate channel considerations into decisions

on pricing strategies, structures, and tactics. Yet,the issue is highly complex, and, although thebasic issue has been identified, the analysis of theproblem is incomplete. We will come back tosome of these principles in the sections below.

4.4 Legal environmentIn setting prices, managers must be aware of legalconstraints that restrict their decision freedom. Inmost countries, governments have installed priceregulations, the objective of which is to defendconsumers and/or preserve competition. In an in-ternational setting, additional constraints havebeen formulated to limit tax evasion or keep cash,employment, and economic activity within coun-try boundaries.

4.4.1 Consumer pricing regulations

In the area of consumer pricing, regulations dealwith deceptive pricing, and with direct price con-trols restricting the range of legally accepted pricelevels.

Governments can influence final consumerprices indirectly by means of VAT rates. They canalso control prices directly by imposing price ceil-ings or price floors for specific product categories.In many European countries, for example, maxi-mum price levels are valid for basic products suchas bread and milk. In addition, ‘minimum pricelaws’ may enforce legal price floors upon retailersto discourage ‘loss leader pricing’, the practice ofpricing selected products below cost to increasestore traffic or drive small retailers out of the market. Besides imposing restrictions on absoluteprice levels, governments can limit the freedom ofcompanies to change prices. Examples of suchmeasures are (temporal) price freezes aimed atslowing down inflation; or regulations on sale pe-riods, limiting the period of time during whichmerchandise can be offered on sale.

In many countries, additional regulations are ineffect to provide buyers with correct informationabout prevailing price levels. Regulations like unitpricing laws, for example, compel retailers to indi-cate price levels clearly on product units or bymeans of shop-window lists. Service firms such as restaurants and hairdressers, for instance, areobliged to display prices outside the store usingsuch price lists. In addition, regulations on decep-tive pricing aim to protect consumers against misleading price information that can materially


affect their buying decisions. Retailers pursuing ahigh–low pricing strategy (see Section 6.4) oftenuse comparative advertising to announce pricepromotions, in which the reduced price is com-pared to a high regular price. In the USA, the FTCAct, and other guides against deceptive prices,stipulate that such practices are illegal when theindicated reference price is not the ‘fair’ or ‘bonafide’ price, a bona fide price being defined as ‘theprice at which the article was offered to the publicon a regular basis for a reasonably substantial pe-riod of time’ (Kaufman et al. 1994). To US courts,the advertised regular price is a bona fide pricewhen a minimum percentage of total volume hasbeen sold at this ‘regular’ price, or when the arti-cle has been sold at this ‘regular’ price, or whenthe article has been offered at this price level dur-ing a minimum percentage of the total time it wasavailable.

4.4.2 Restrictions on competitive pricingand channel pricing

Manufacturers’ pricing decisions are further re-stricted by government regulations that aim topreserve competition and avoid monopolies andcollusion among firms. In assessing the implica-tions of these regulations for pricing decisions,marketing managers should take into account notonly government legislation (legislated law), butalso the interpretation of this law by major courts(Nagle and Holden 1995). For many of the regula-tions discussed below, for example, pricing prac-tices that can be demonstrated to be beneficial toconsumers or not to harm competition consti-tute exceptions that are legally accepted by mostcourts.

Horizontal price fixing consists of agreementsamong competitors to fix prices at a certain level.As these agreements may reduce competition andraise consumer prices, they are prohibited by theSherman Act in the USA and by Article 85 of theTreaty of Rome in the EU. Price agreements be-tween manufacturers and their distributors arealso illegal when they enable manufacturers to en-force minimum resale prices (vertical price fixingor resale price maintenance). Manufacturers are,however, allowed to announce recommended re-sale prices, and to refuse to deal with distributorsselling below suggested prices (Nagle and Holden1995).

Price discrimination refers to the practice of charg-ing different prices for the same product to differ-

ent customers or segments. It is prohibited by lawwhen it is intended to, or has the effect of, reduc-ing competition. In the USA, price discriminationis regulated by the Robinson–Patman Act. In theEU, similar stipulations are valid (Treaty of Rome,Article 85). US courts generally accept two excep-tions to the rule that equal prices should becharged: price differences are accepted if they re-flect differences in manufacturing or distributioncosts, or if they are needed to adjust to (low pricesof) local competitions (Nagle and Holden 1995). In the EU, price discrimination among memberstates is generally considered to be illegal, exceptwhen price differences are a reflection of cost differences.

In the case of predatory pricing, price is set at alow, unprofitable level to drive out competition, a practice that is prohibited by the Sherman and Robinson–Patman Act in the USA. Wherepredatory-pricing cases were previously judged bycomparing (marginal or average) costs to prices,courts now increasingly apply a ‘rule-of-reason’approach, and concentrate on the expected conse-quences and feasibility of alleged price predation.Whether pricing is deemed predatory and there-fore illegal is assessed by examining whether ef-fective entry barriers could be created and thecompany would be able to recover lost profits byraising prices after competition has been reducedor eliminated (Nagle and Holden 1995).

Tie-in or sales requirements contracts, finally, obligebuyers of a given product to purchase other prod-ucts exclusively from the seller. Such (re-)purchaserequirements are considered illegal when theyhave the effect of or are intended to reduce com-petition. This is true in the USA as well as in theEU.

4.4.3 International setting

In international markets, government regulationscan affect prices indirectly through import dutiesand other import barriers that increase costs. Ex-cept when additional import costs are not passedon to consumers but carried by the importing orexporting firm, import duties will result in pricedifferences between domestic and export mar-kets, and possibly among export markets.

Import duties have an impact on the transferprices a company charges to its foreign sub-sidiaries: import duties expressed as a percentageof unit value (price) drive transfer prices down. Ad-missible transfer-price levels are further restricted

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by government regulations aimed at preventingtax evasion. By charging high transfer prices tosubsidiaries located in countries with high taxrates, taxation bills in these countries could be artificially reduced.

Similar to predatory pricing laws, anti-dumpingregulations prohibit companies from charging un-fairly low prices in export markets with the intentof injuring domestic competitors. Whether the ex-porter’s price is ‘unfair’ is commonly assessed bycomparing the dumping price with the exporter’sdomestic price level or the exporter’s productioncosts.

5 Pricing objectives

Environmental analysis generates fundamentalinputs to pricing objectives. Indeed, pricing

objectives should, in line with overall companyobjectives, strengths, and weaknesses, exploit the possibilities of the marketplace. Pricing objectives can be classified in a number of ways. A typical, and fairly general, classification dis-tinguishes between objectives that are profit oriented, volume oriented, cost oriented, andcompetition oriented. Examples of each type aredisplayed in Box 10.1. As these examples demon-strate, pricing objectives may coincide with over-all company objectives (e.g. profit maximization),or be directly related to pricing decisions (e.g.price leadership). While profit maximization isthe most often-cited company objective, it is sel-dom the exclusive goal of the company. Most com-panies do not pursue one single objective, but aseries of them, with priorities placed on varioussub-objectives, or one criterion to be optimizedsubject to a ‘minimum’ performance on other di-mensions. In such cases, sub-objectives must bemutually consistent.

Specifying overall pricing objectives is essential.They have a major impact on the location of priceboundaries. They also affect whether the companyshould pick prices near the lower or upper boundof its acceptable price range. Clearly, volume-oriented objectives suggest low prices, whileprofit orientation requires a trade-off between vol-ume and unit profitability, and therefore requiresintermediate prices. Competitive considerationslike entry deterrence, or cost objectives such aspursuit of economies of scale and experience ef-fects, push the company towards the low end of

the price range. Overall objectives thus providegeneral guidance for price decisions.

Yet, effective pricing requires companies to gobeyond the overall pricing objectives just men-tioned, and to specify what Nagle and Holden(1995) refer to as pricing goals. These goals aremore concrete, have specific deadlines, refer tospecific ‘objects’ or units, and usually apply to spe-cific activities. The period in which one wants toobtain results crucially affects price decisions: different strategies may be needed to maximizeshort-term profit (for example, through liquida-tion of excess inventories) versus long-term profit(for example, through maximizing customer life-time value). As far as the ‘object’ or unit of analysisis concerned, several options could be contrasted.Within the confines of the company, results couldbe pursued for products versus product lines, oractions could be taken that benefit the companyversus the decision-maker’s own career. From achannel perspective, decisions could stimulateprofit for the channel as a whole, or concentrateon one level. Not-for-profit companies could at-tempt to increase consumer versus total surplus.In international settings, local or global profitscould be strived for.

Having specified overall pricing objectives andpricing goals, the next question is how to generatethe desired outcomes, and what key issues to address. Interesting insights can be obtained froma classification provided by Tellis (1986). Tellis distinguishes three types of what we refer to as‘derived’ objectives. A first would be to exploitconsumer heterogeneity and the presence of market segments. Secondly, the company can use


its competitive position as a basic ‘asset’ for pricing. Thirdly, opportunities offered by product-line pricing could be exploited. These derived objectives already suggest means or courses of action to achieve overall pricing objectives andgoals. Together with key environmental character-istics, they form a ‘bridge’ to a taxonomy of pric-ing strategies, our point of interest in the nextsection.

6 Pricing strategies

Awide range of pricing strategies have been put forward by academics and practitioners,

and different labels have been used to denotethem. The appropriateness of a strategy is linked to environmental characteristics—espe-cially those of the target market (Tellis 1986; Nagle and Holden 1995)—and to company objectives. Asoutlined above, a revealing taxonomy of objec-tives has been put forward by Tellis, who dis-tinguishes between segment-, competition-, andproduct-line-based objectives. Coupled with char-acteristics of the target market, these derived ob-jectives give rise to a matrix with nine genericapproaches to strategic pricing (see Fig. 10.3). InSections 6.1, 6.2, and 6.3 we explain Tellis’s classi-fication of pricing strategies, and supplement itwith subsequent findings from the marketing lit-erature and practice. Section 6.4 puts the taxon-omy into a wider perspective, and comments onthe meaning and use of the generic strategies inspecific settings.

Box 10.1 Pricing objectives

Profit oriented Volume oriented Cost oriented Competition oriented

Maximize profit Sales growth or Pursue economies of scale Price leadershipReach target return on maintenance Entry deterrenceinvestment Market share growth or Exploit experience effects Market stabilizationMaximize market maintenance Meet competitionskimming Market penetration Recover investment costs

Increase usage,participation, or storetraffic

6.1 Segmented or differentialpricing strategiesSegmented or differential pricing strategies aim toexploit heterogeneity among consumer segments.

In random discounting, the company sets the regular price at a high level, but offers temporaryprice cuts at random points in time. It thus exploits consumer heterogeneity in price knowl-edge and search costs: knowledgeable consumerssearch for bargains and buy the product at the lowprice, while others usually pay the regular price. Ifsome consumers are uninformed and willing topay more, the random-discounting strategy allowsthe company to preserve a broad customer base atthe same time as charging less knowledgeable andprice-sensitive consumers a high price.

Periodic discounting implies that prices system-atically change over time to exploit consumers’ willingness to pay different prices at differenttimes. A typical example is peak-load pricing,where lower prices are charged in off-season peri-ods. In price skimming, a new product is highlypriced in the introduction phase, and graduallybecomes cheaper over time. End-of-season salescan also be placed under the heading of periodicdiscounting.

While, in the previous strategies, differences in prices paid by consumers result from self-selection, second-market discounting is a more direct

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form of price discrimination. This strategy explic-itly stipulates that different prices be charged todifferent consumer segments. Segments could bedefined in geographic terms, or based on con-sumer characteristics other than location. A typi-cal example is dumping, where the same productis offered at a high price in one market (often thecountry of origin), and at a lower price in other(more price-sensitive) markets. Price discrimina-tion based on consumer identity or membership(e.g. lower rates), and trade discounts offered bymanufacturers to distributors performing specificfunctions, are also illustrations of second-marketdiscounting. Price quantity discounts, aiming toattract heavy users with higher price sensitivityand lower holding costs, can also be seen as a formof second-market discounting. In each of these examples, transaction costs or other barriers prevent consumers from shopping in a cheapersegment.

6.2 Strategies exploitingcompetitive positionWhile the foregoing strategies imply that differ-ent prices be charged for the same product to dif-ferent segments, this is not true for the strategiesdescribed in this section, the logic behind which isto take advantage of the firm’s competitive posi-tion in the market.

Vary prices amongconsumer segments

Exploit competitiveposition

Balance pricing overproduct line

Image pricing

Price bundlingPremium pricing

Price signalling

Penetration pricingExperience curvepricing

Randomdiscounting

Periodicdiscounting

Second-marketdiscounting

Geographic pricing Complementarypricing

Some have highsearch costs

Some have lowreservation price

All have specialtransaction costs

CHARACTERISTICSOF CONSUMERS

OBJECTIVE OF FIRM

Source: Tellis (1986: 148).

Figure 10.3 Taxonomy of pricing strategies

In price signalling, a low-quality product is offeredat a high price and targeted at non-knowledgeableconsumers. These infer quality from price, poss-ibly because of the positive price–quality relation-ship of competitive offerings. Following Tellis, aprerequisite for this strategy is that some com-petitors are ‘honest’ in the sense that they offerhigh/low quality at high/low prices, and that somesegments of consumers have high search costs.Parker (1995) refers to the products for whichprice signalling is used as ‘sweet lemons’. Heposits that sweet lemons can prevail even if thereis no link between objective price and quality forany firm—for example, if none of the suppliers is‘honest’. This is true in markets with extreme in-formation asymmetry between the supplier(manufacturer or retailer) and all customers, andwhere prices are driven up by advertising claimsconcentrating on certain (irrelevant) quality as-pects. Medical care and legal services are examplesof such markets. Along the same lines, Alpert et al.(1993) stipulate that price signalling is more effec-tive (1) when consumers are able to get informa-tion on price more easily than information aboutquality, (2) when buyers want the high qualityenough to risk buying the high-priced producteven without certainty of high quality, and (3)when there are a large number of uninformedconsumers. The market of skin moisturizers is anillustration of a market satisfying those condi-tions. Hence, though high-priced moisturizersoften show little superiority, they succeed in securing a substantial portion of the market (seeAlpert et al. 1993).

In penetration pricing and experience curve pricing,new products are introduced at low prices. The ob-jective is to exploit pioneer advantages: low pricesattract and capture the price-sensitive consumersegment, or build up economies of experience before competitive entry occurs. The low pricesare thus justified by the presence of a number ofprice-sensitive customers in the market.

This is also the basis for a recently uncoveredstrategy that we refer to as ‘advertised discount-ing.’ In advertised discounting, the company offers infrequent, irregular promotions on high-quality items, and announces them through ad-vertisements. The strategy may be appropriatewhen consumers have different reservation pricesand price/quality trade-offs. In such markets, high-quality brands enjoy asymmetric promotion ef-fects: they are able to attract more switchers fromlow-quality brands through promotions than vice


versa. Advertised discounting is thus a competi-tive strategy: it is used by quality brands againstlower-level brands or private labels, to take advan-tage of their superior competitive position and theresulting asymmetric promotion effects (see alsoSection 4.1.2 and Section 8). In advertised dis-counting, price cuts should be sufficiently infre-quent and irregular for the long-term equity of thepromoted brand not to be harmed.

Geographic pricing, or ‘spatial pricing’, is a pricingstrategy adopted by firms serving different geo-graphic markets, where transportation cost is animportant component of transaction cost. Pricesto be charged in various regions depend on com-petitive conditions in those regions and on con-sumer valuation of transaction costs and prices invarious markets. Possible strategies are f.o.b. (cus-tomer pays for transportation), uniform delivered(company delivers product in all markets at thesame ultimate price and thus incurs transporta-tion cost), or an in-between strategy (zone pricing).

6.3 Product-line pricing strategiesProduct-line pricing strategies can be used bymulti-product firms, and involve balancing pricesover different products in the assortment.

Firms that apply image pricing sell an identicalproduct, often under a different name, at a lowprice (to knowledgeable consumers) and at a highprice (to consumers considering price as a qualityor ‘status’ cue). Categories where image pricing isoften used are wines and cosmetics.

In price bundling, two or more products in a linethat constitute ‘imperfect substitutes’ or comple-ments are sold together at a special price. Abundling strategy can be ‘pure’, ‘mixed’, or ‘ampli-fied mixed’. In pure bundling, all products have to be purchased together. In a mixed bundlingregime, the customer may purchase the wholebundle at a special price, but can still obtain indi-vidual products separately at their ‘normal’ price.In the case of amplified mixed bundling, there isan additional option of buying a subset of the bun-dle products together at a special rate. Pricebundling may be profitable if consumers differ intheir willingness to pay for the separate com-ponents of the bundle. Venkatesh and Mahajan(1993) point out that customers’ reactions to abundle depend not only on their reservationprices for the separate items, but also on theirprobable consumption rates of the tied good. Anexample would be the reaction to season tickets

for theatres, where the attractiveness of the sea-son ticket depends on the likelihood of havingtime to attend several performances. From thisperspective, mixed bundling—with higher pricesfor bundle and for individual items than underpure strategies—may effectively discriminateamong frequent and occasional users. The bundlewill attract those who expect to have high-userates, and whose mean reservation prices arehigher than the mean prices of the separate items.In a sense, price-quantity discounts, where largerpackage sizes (bundles) are offered at lower unitprices so that customers are persuaded to pur-chase and consume more, can be seen as an example of this strategy.

The adoption of premium pricing implies thathigh-quality products in a line are sold at a veryhigh price. This high price level compensates forthe loss incurred on low-quality products that arepriced below cost. The appropriateness of thisstrategy depends on the presence of economies ofscope, and on differences in consumer reservationprices. Some hotels, for instance, adopt premiumpricing: the rate they charge for ‘luxury’ roomsand suites by far exceeds the regular room rate. Asecond example is the automobile industry, wherehigh prices for large cars have to compensate forlow margins on small cars.

In complementary pricing, some products in theline are sold at a low price, but a ‘premium’ ischarged on complementary products in the linethat are hopefully bought on subsequent occa-sions. This strategy is based upon the ‘comple-mentary’ or ‘captive’ nature of the market. Havingbought the first product, consumers incur trans-action costs to switch to other (competitive) product lines. The presence of these transaction costs allows the company to charge more for thesecond (complementary) product. An examplewould be a manufacturer charging a low price forcomputer games’ hardware, and high prices foraccompanying software. A variant of complemen-tary pricing is ‘loss leadership’ by retailers (seeSection 4.4.1).

6.4 DiscussionThe taxonomy developed by Tellis offers a simpleintegrative scheme for positioning and under-standing a wide range of pricing strategies. Yet,being a stylized scheme, Tellis’s framework neces-sarily has some limitations for managers inter-ested in developing concrete pricing strategies.

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First, the framework allows only an indirecttreatment of price dynamics and multi-tieredprice decisions (channel pricing).

Dynamic pricing strategies can, for example, be fol-lowed to exploit reference price effects (see e.g.Greenleaf 1995), to obtain insight into consumers’price reactions, or in anticipation of future prod-uct improvements in highly innovative markets(see e.g. Padmanabhan and Bass 1993).

Multi-tiered price decisions or channel pricing are aparticularly complex issue that presents problemsand opportunities not accounted for in Tellis’sframework. Pricing affects how much profit thechannel obtains as a whole, as well as how thisprofit is allocated within the channel. In indepen-dent channels, there often exist conflicts of interest or ‘sources of channel miscoordination’.Information asymmetries, for instance, can jeop-ardize coordination: manufacturer research maycharacterize the product as a certain winner, butthe retailer does not blindly accept this and refuses to carry the product. Another example of channel miscoordination is the problem of‘double marginalization’. When a retailer withsome monopoly power sets a high price to maxi-mize his own profit, and the manufacturer alsoseeks high profit, the margin for the entire chan-nel can become excessive. As a result, consumersthat would be profitable clients for the integratedchannel may be excluded. Other factors causingchannel conflicts are summarized in Gerstner andHess (1995). In situations where such conflicts areimportant, improving channel coordination mayconstitute an alternative or additional pricing ob-jective. Specific pricing strategies may be requiredto overcome or attenuate these conflicts, and leadto a fair allocation of profit within the channel.For instance, ‘targeted pull’ strategies, where themanufacturer offers a discount directly to price-sensitive consumers who then ask the retailer forthe product, are a way to overcome double mar-ginalization (Gerstner and Hess 1995). Profit-shar-ing arrangements constitute another example of aconflict-resolving strategy. Additional illustrationsof how channel interdependencies affect pricingare discussed in Section 8.

� ‘Bekaert motivates its dealers not only by providing an excellent assortment,

but also by granting substantial margins, bymaintaining stocks instead of its dealers, and bydelivering within twenty-four hours of an orderbeing placed.’ (Chapter 9, p. 196)

Another limitation of Tellis’s taxonomy is that itpresents only generic pricing strategies. Thesestrategies may take different forms depending onthe situation; managers should translate thegeneric principles into a form tailored to their spe-cific situation. More importantly, most real life situations allow for the use of a combination ofstrategies. For example, two basic approaches topricing by retailers are every day low pricing(EDLP) versus high–low pricing (Hi-Lo).

An EDLP approach resembles a uniform pricingstrategy, where the retailer charges permanentlylow prices. Following Levy and Weitz (1995), thisstrategy emphasizes the continuity of prices at alevel somewhere between a ‘regular non-saleprice’ and deep discount sale price. It is for thisreason also referred to as ‘every day stable prices’.The Hi-Lo strategy, in contrast, is characterized byhigher regular prices, but which are accompaniedby frequent temporary price cuts on selecteditems. Retailers adopting a Hi-Lo approach (some-times referred to as promo-stores) often buy theirmerchandise on deal. According to Lal and Rao(1997), EDLP and Hi-Lo are not merely pricing, butoverall positioning strategies. EDLP stores try tosecure a sufficiently large customer base throughlow prices. Promo stores, in turn, offer higher service and larger assortments permanently to attract service-sensitive consumers (with highertime constraint) for all their products. They usethe promotions to appeal to cherry-pickers for the promoted items, eventually even convincingthem to buy non-promoted merchandise from thestore. The Hi-Lo strategy therefore combines prin-ciples of random discounting (selling promoteditems to price sensitive consumers through irregu-lar promotions) and of complementary pricing (con-vincing consumers to buy other items at regularprices once they are in the store).

Various authors have discussed the advantagesand disadvantages of EDLP versus Hi-Lo ap-proaches (see e.g. Levy and Weitz 1995). WhileEDLP leads to reduced price and advertising warsand stockouts as well as to improved inventorymanagement, profit margins, and customer service, Hi-Lo allows for more emphasis on qualityand service, creates excitement, and helps movemerchandise.


7 Price determination

The pricing strategy outlines the company’sbasic approach to pricing. The next step is to

develop a price structure, which specifies how thecharacteristics of the product will be priced, andlays the foundation for how price levels will be set(Stern 1986). More specifically, the price structuredetermines: (1) for which aspects of the product orservice prices have to be set, (2) how prices willvary over customer segments or products in theline and (3) the timing and conditions of payment.In this section we start out discussing price struc-tures accompanying the generic pricing strategiesdescribed above. Next, we have a look at someprice structures used in specific settings.

7.1 Price structureA company adopting a random-discounting strat-egy faces decisions on the depth, frequency, andtiming of the discounts: how large should theprice cut be, how many discounts should be offered per period, and when exactly should pro-motions occur? Other decisions relate to thechoice of promotion instrument (e.g. straightprice cut or a rebate), and the way it will be com-municated (e.g. using in-store displays or featureadvertising). For a multi-product company, the se-lection of the item(s) to be put on promotion isalso primordial.

While the strategic rationale for random dis-counting is clear-cut, deciding upon the accom-panying price structure remains a difficult issue.Each of the aforementioned price-structure deci-sions has a major effect on company outcomes. Amore detailed discussion on the impact of variousdiscount structures is given in Section 8.

In strategies such as penetration pricing, expe-rience curve pricing, and seasonal discounting, anoptimal price trajectory needs to be specified.

For penetration and experience curve pricing,the company must decide on the initial price levelas well as on the pattern of price adaptations overtime. Crucial ingredients in these decisions arethe reservation prices for various customers, andthe magnitude of loyalty or experience effects.Lowering the initial price implies that the company loses money initially on customers will-ing to pay more, but this may be made up for by alarger ‘loyal’ customer base or stronger cost posi-tion by the time competitors enter the market.

prices charged by local competitors’ (see e.g.Dahringer and Mülbacher 1991). Major factors affecting the choice and appropriateness of an international pricing strategy are the degree ofvariation in price sensitivity, competitive positionand/or costs across export markets. Other factorsthat may influence the choice between a global,differentiated, or ‘mixed’ pricing strategy areproduct characteristics (e.g. commodities versusintangibles), government regulations, the lengthof and degree of control over distribution chan-nels, and the knowledge and experience of the ex-porting firm (Dahringer and Mühlbacher 1991;Toyne and Walters 1993). In addition, as for re-tailer pricing strategies, the choice between aglobal and a differentiated approach is usually notrestricted to pricing decisions, but rather repre-sents an overall company strategy that affectspricing as well as other marketing decisions (forexample, advertising).

7.2 Determining price levelsWhatever the pricing strategy and structure acompany adopts, it ultimately has to arrive at pricelevels for specific items, target markets, and periods. Such prices may be unilaterally specifiedby the company (‘fixed price levels’), or may resultfrom interactions between buyers and sellers. Inthis section we discuss methods for assessing fixedprice levels, the basic principles of price negotia-tions, competitive bidding, and then leasing.

7.2.1 Fixed levels

To determine price levels, companies often makeuse of simple decision procedures that focus onone dimension of the pricing problem. We firstdiscuss these simplified methods, and then touchon complex optimization, simulation methods,and price adjustments.

Simplified decision methods Among the sim-plified decision procedures, cost-based methodsare the most widely used approaches to pricing.

Cost-based methods have a common denominator:they start out from information on unit costs forthe product, and take this as a ‘floor’ above which apre-specified remuneration is charged by the com-pany. In mark-up pricing, the company sets a priceper unit equal to the cost per unit plus a pre-specified ‘mark-up’. Mark-ups are often specifiedas a percentage of unit cost, and vary widely be-tween sectors and product categories. An alterna-


tive cost-based method is target return pricing. Here,the company starts out from a desired return on in-vestment (ROI), and then calculates the premiumto be charged over unit cost to realize this ROI. Inbreak-even pricing, finally, the company computesthe minimum price needed to cover fixed and variable costs (and, eventually, a pre-specified ROI)in view of the forecast demand level. Box 10.2 illus-trates the different cost-based pricing principleswith a simple example. Cost-plus pricing is used ina wide range of consumer and industrial settings,and is adopted by almost all retailers.

Competition-oriented rules of thumb concentrateon competitive price levels to determine the com-pany’s own price. The most simple procedure isthat of ‘going rate pricing’, where the companysimply aligns its own prices with those prevailingin the marketplace. A similar procedure is fol-lowed by some international companies, whichtry to maintain a ‘global’ competitive position bysetting prices relative to competitors’ price levelsin each export market.

Demand-oriented methods take the customers’willingness to pay as the basis for pricing. A popu-lar approach, especially in industrial settings, isperceived-value pricing. The basic idea is to set pricein such a way that the ratio of perceived value toprice for the company’s product equals that ofcompetitors. Perceived value can be calculated asa weighted average of the products’ perceived at-tribute scores.

While the simplified pricing methods are ex-tremely popular, they suffer from basic defects.Cost-plus pricing rules forgo the link betweenprice and demand: they start out from estimatedvolume (and associated unit cost) to set price, butignore the crucial impact that this price will haveon ultimately realized volume. Competition-ori-ented approaches ignore differences in cost anddemand between the company and its competi-tors. These methods rely upon the ‘collective wisdom of the market’, and their outcomes de-pend on the selection of competitors whose priceswill be mirrored. Perceived-value pricing resolvessome of these problems by allowing differences inperceived value to affect prices, yet it does so in asimplified manner. Multi-product and channelconsiderations, as well as market heterogeneityand dynamics, are ignored in each of the ‘simpli-fied’ approaches discussed in this section.

Each of these procedures concentrates on onemajor environmental factor (cost, demand, com-petition), and basically ignores the others. As a

result, each method separately yields only partialinsights at best. At the same time, though, the approaches are complementary. Applied incombination, they may provide an indication ofthe range of acceptable prices within which a spe-cific price has to be selected.

Optimization methods Optimization methodstake on a different approach: they try to derive anoptimal price level analytically or numerically.Optimization methods start out with the specifica-tion and estimation of demand and cost functions.Occasionally, competitive and channel intermedi-ary response functions are also formulated. Next,the pricing objective is identified. In a last step, op-timal prices are derived using mathematical tech-niques. Optimization methods can deal with avariety of complex situations. They can set pricesfor single products as well as product lines, and for single periods as well as multiple period

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sequences (trajectory models and optimal controltheory). Competitive reactions and channel inter-dependencies (game theory) may be explicitly in-corporated. Other complicating factors such asdemand heterogeneity and uncertainty, asymmet-ric or limited information, and psychological effects can also be accounted for.

Yet, in order to allow for analytical solutions,many optimization methods rely on simplifiedmodels and assumptions. Others pursue numeri-cal optima for less restrictive settings, but necessi-tate the use of extremely complex optimizationroutines. In any of these approaches, one is con-fronted with the problem of a priori model speci-fication. As pointed out by Kalyanam (1996):‘Demand functions are latent constructs whoseexact parametric form is unknown. Estimates ofprice elasticities, profit maximizing prices, etc.are conditional upon the parametric form em-ployed in estimation. In practice, many forms may

Box 10.2 Illustration of cost-based pricing rules

A manufacturer of toothbrushes considers the following costs and demand level:Production costs Bfr. 1,000,000 fixed costs per month

Bfr. 20 variable costs per unitExpected demand 20,000 units per month

(1) To earn a mark-up (MU) of 20% on price, the following unit price should be charged:

In this example, mark-up (MU) is specified as a percentage of the selling price. Alternatively, MU can be defined asthe margin by which price exceeds average costs (mark-up price = average cost ¥ (1 + MU)).

(2) A target return of 8% on investments (INV = Bfr. 2,000,000) per month results in the following price level:

(3) The break-even price level at which total returns cover total costs, finally, equals:

Break-even price = Total cost Sales

Bfr. 1,000,000+Bfr.20 20,000 units20,000 units

Bfr. 70 per unit

=

=

¥

Target return price= AC+INV ROI

Sales

Bfr. 70+Bfr. 2,000,000 0.08

20,000 units =Bfr. 78 per unit

¥

=¥

Mark-up price = AC MU

Bfr. 70

1 0.20Bfr. 87.5 per unit

Average cost, AC Bfr. 20+Bfr.1,000,000

20,000Bfr. 70 per unit

1-( )

=-

=

= =

be found that are not only theoretically plausible,but also consistent with the data, yet lead to dif-ferent (optimal) pricing implications.’ Solutionsare currently suggested to reduce the impact ofspecification error, but none of these is widely ap-plicable yet.

Simulation methods Simulation methods aresimilar to optimization methods, except that theprice recommendations are obtained in a differ-ent fashion. No ‘optimal’ prices, but near-optimalor satisfying prices are derived from a comparisonof alternative scenarios. Simulation methods areoften used in combination with conjoint analysis,a technique for estimating ‘utility’ functions forexisting or new products. Conjoint Analysis is thebasis for simulating demand in various price set-tings. Combined with cost functions, it can yieldoverall insights into profit implications of alterna-tive price levels. Simulation may be applied tocomplex problems and settings. Yet, as for opti-mization, simulation applied to comprehensivesettings may become complex, and necessitate thecollection of a large amount of information.

Price adjustments While the previous methods,alone or in combination, help determine the appropriate amount to be charged to consumers,small adaptations may be needed to translatethem into price levels. These adaptations are inline with practical requirements and originatefrom psychological pricing issues. In particular,principles of odd pricing and of price lining (thepractice of using a limited number of price pointsto price products in a line) may be highly relevanthere. As indicated earlier, both have psychologicalas well as practical implications, and therefore deserve managerial attention.

7.2.2 Negotiations

In price negotiation, sellers and buyers make anumber of proposals and counter-proposals before a price is agreed upon. Price negotiation istypical in industrial marketing, and especially incomplex buying situations. Very often, the nego-tiations are not limited to price alone, but equallyencompass discussions on quality, service, termsof delivery, and maintenance (Reeder et al. 1991).

Negotiations can evolve following four bargain-ing strategies that reflect the relative strength orpower of both parties involved. A negotiated strat-egy occurs if buyer and seller are strong, and strivefor a win–win or fair price. In a dictatorial strat-


egy, the seller has the dominant position, and triesto impose a price favourable to him. The reverseholds in a defensive strategy, where a weak sellermay have to settle for a price that is more advanta-geous to the buyer. Finally, if both buyer and sellerare weak, a gamesmanship strategy results, inwhich each party tries not to reveal its position inbargaining for a price (Reeder et al. 1991). The rela-tive strength of seller and buyer is a crucial deter-minant of how the negotiations will proceed. Thestrength of the buyer typically increases withcompany size as well as past and expected pur-chases. Seller power is positively linked to unique-ness and quality of the product and services,delivery, and technical and post-sale service capa-bilities. Furthermore, whether the negotiationstyle is competitive rather than cooperative is con-tingent upon factors such as negotiation exper-tise, attitude, perceived role, number of issues tobe discussed, number of parties present, timepressure, and atmospherics.

Negotiation tactics, or specific manœuvres inthe course of the bargaining process, will primar-ily depend on whether there is an acute, moder-ate, or marginal need for the buyer to buy, and forthe seller to sell the product. The speed of theprocess overall depends on the urgency of theseneeds, as does the length of subsequent negotia-tion stages. Successful negotiation, like all pricingdecisions, requires careful analysis of internal andexternal environmental factors. For each aspect ofthe ‘exchange’ between buyer and seller, one hasto assess whether it is a non-negotiable, prime-trade-off, or non-value factor. Non-negotiable fac-tors are those for which companies have strictrequirements that are not open to debate. Non-value factors are of no importance to the decision.Prime-trade-off factors constitute an in-between;they are a subject of discussion in the course of thenegotiations. Not only assessment of the com-pany’s own range of acceptable values on each factor, but also anticipation of the desires of thebuyer, are crucial inputs for successful bargaining.The discussion on internal and external factors affecting price (see Sections 3 and 4) may provehelpful in identifying those factors and levels.

7.2.3 Competitive bidding

In a number of markets, transactions are based oncompetitive bidding rather than on the basis of‘established’ prices for products. Competitive bidding often occurs for the purchase of tailor-

made products or services that do not have a mar-ket price, or for complex items with varying levelsof specification and quality. Many governmentagencies and institutions are required to gothrough a bidding system for all their purchases.In closed competitive bidding, the potential buyerformally invites sellers to submit—before a givendate—sealed bids, specifying the characteristicsand price of the offer. After the deadline, all bidsare reviewed and the most appealing one (often,but not always, the one with the lowest price) se-lected. In open bidding, which is a more informalprocess, sellers make a series of subsequent offersbefore the specified date; open bidding, therefore,closely resembles negotiations.

Sellers operating in a market where competitivebidding prevails should carefully prepare theirbids. Traditionally, competitive bidding proceedsin two stages: pre-bid analysis, and bid determina-tion. The pre-bid analysis stage uses informationfrom the internal and external environment, com-bined with information on pre-specified objec-tives, to ‘screen’ the bid opportunities. To decideupon the contracts to bid for, simple scoring pro-cedures may be used. Such procedures first iden-tify ‘relevant factors’ for bid selection, and theirimportance weights. Then, bid opportunities arescored on each factor, and the weighted sum ofthese scores leads to an overall evaluation of eachbid. Having selected a limited number of bids, thecompany moves to the stage of bid determination,in which it is attempted to establish the bid pricethat maximizes expected profit. Anticipated profitis the product of two components: the probabilityof winning the bid as a function of price, and theprofit obtained when carrying out the contract atthat price. While costs constitute a crucial input tothe second component, the probability of winningis more difficult to assess. It requires considera-tion of potential competitors and the characteris-tics of their offer, coupled with their anticipatedprice level. Historical data on past bids may serveas a cue in anticipating competitors’ bidding actions.

7.2.4 Leasing

In industrial markets, leasing may be an interest-ing alternative to buying for the acquisition of capital goods. Leasing allows the industrialcompany to pay for the equipment by periodicalinstalments. A distinction can be made betweentwo major types of leasing contracts: financial

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leases, and operating or service leases. Financialleases are typically long-term contracts that arefully amortized and usually include the option topurchase the product at the end of the contract.Operational leases are usually short-term, notfully amortized contracts, directed towards cus-tomers that need the equipment only temporarily.Operational leases often include maintenance andservice provisions. From the customer’s perspec-tive, major advantages of leasing compared tobuying consist of tax advantages, piecemeal fi-nancing, and the avoidance of interest and operat-ing expenses (Haas 1992). A major disadvantage isthat in most cases the customer will have to paymore for the equipment than when it is purchaseddirectly. The difference in overall cost betweenbuying and leasing options depends on the pricestructure set by the capital-goods company. Be-sides setting product prices for regular purchase,sellers offering lease contracts have to decide onthe amounts and frequency of periodical leasepayments, the duration of the lease contract, andthe residual price for contracts with purchase op-tion. Through its price structure, the company canencourage leasing, stimulate purchase rather thanleasing, or try to achieve a balance between leaseand sales rates. Leasing arrangements should be inline with the company’s objectives. Sellers aimingat increasing penetration in market segmentswith limited financial resources, establishinglong-term relationships with customers, or meet-ing competition in markets where leasing iswidely used view leasing as an essential instru-ment in strategic pricing (Haas 1992).

8 Pricing strategy versustactics

In the literature, the term ‘pricing tactics’ is sub-ject to much confusion. In this text, we adhere to

the viewpoint of van Waterschoot and Van denBulte (1992) and Morris and Calantone (1990),which is that pricing strategies determine long-term price structure and levels (regular prices) andtheir evolution over time in response to long-termenvironmental changes, while tactics refer toshort-term price decisions to realize short-termobjectives or respond to short-term environmen-tal changes. Often, the same instruments are usedfor strategic and tactical purposes. A temporary

price cut, for instance, can be part of a random-dis-counting strategy, or intended to pursue an imme-diate goal like liquidating excess stocks. For manycompanies, discounting is ‘correctional’, in re-sponse to sudden changes in consumer demand(taste, weather), trading conditions, and opera-tional inefficiencies. At the same time, the strate-gic role of short-term price fluctuations is welldocumented and has been extensively discussedin previous sections of this chapter. In this sectionwe concentrate on empirically observed effects ofshort-term price reductions or ‘price promotions’.As the literature on promotions is extensive, wekeep the discussion tractable by studying onlyprice discounts in their purest form. Coupons, orother short-term marketing instruments such asgifts or extra quantities, are not considered here.Also, our discussion is based mainly on studies inthe packaged-goods sector, which constitute thebulk of the promotion literature. We thereforeanalyse consumer and retailer promotions (of-fered by the manufacturer and retailer, respec-tively, to consumers), and trade promotions(offered by manufacturers to retailers).

8.1 Consumer and retailpromotionsWhen studying the impact of price promotions,we make a distinction between their effect on thepromoted item itself, and the implications forother items. In each case, short-term as well aslong-term effects are considered.

8.1.1 Impact on the promoted item

The literature on short-term effects for a promoteditem is extensive, and yields a number of interest-ing generalizations and issues for discussion. It isgenerally accepted that temporary price cuts havea substantial impact on sales, resulting in a short-term sales spike (see Blattberg et al. 1995). Someauthors conjecture that promotion effects followthe ‘80, 15, 5 rule’, implying that 80 per cent of thissales spike results from brand switching, 15 percent from changes in purchase acceleration, and 5per cent from increased purchase quantity or‘stockpiling’. This issue is subject to debate,though, and the source of the sales spike stronglydepends on category characteristics (cf. below).

A number of authors report that short-termprice cuts have a stronger impact than regularprice changes, the difference being explained bythe temporary nature of promotions. This tempor-


ary character increases stockpiling, acceleration,and consumption, and is associated with a highertransaction utility (see Blattberg and Neslin 1989).Others feel that promotions and regular changeswork exactly alike, a statement that probablyholds in some categories but not in others.

� ‘In a country like Sweden, consumers have become so used to sales promo-

tions that many will not buy anything that is noton sale, whereas consumers in Germany are notused to this and therefore have not developedthe same kind of behaviour.’ (Chapter 6, p. 126)

It is widely accepted that higher-share brandsare less ‘deal elastic’ (see Blattberg et al. 1995). Atthe same time, there is evidence of asymmetricswitching: promotions for higher-quality brandsattract more buyers from lower-quality brandsthan promotions for low-quality brands attracthigh-quality buyers. Finally, as indicated earlier,price discounts are found to interact strongly withother marketing-mix instruments: promotionssupported by POP signals or ads yield significantlylarger sales spikes.

From a long-term perspective, much less isknown about promotions. Some argue that pro-motions may be ‘consumer franchise building’ or contribute to a positive consumer attitude towards the product (franchise), thereby increas-ing market share in the long run. However, thereis no solid evidence of such effects. In their paperon promotion-effect generalizations, Lal and Pad-manabhan (1995) find no relationship betweenmarket share and long-run promotional expendi-tures. For many products, long-run market sharesare stationary (i.e. do not increase or decrease). Forproducts where market share exhibits a trend,this cannot be directly attributed to a positive impact of promotion expenditures. Conversely,there are indications of negative promotion ef-fects beyond the promotion period, where pur-chase acceleration and stock building lead to apost-promotion trough in sales. Evidence on theexistence of post-promotion dips is, however,mixed (Blattberg et al. 1995). This may result fromthe difficulty in assessing true incremental salesfrom promotions based on aggregate data. Post-promotion dips may exist at the individual level,but may be ‘masked’ by aggregation because ofthe timing of consumer purchases, retailer andcompetitive behaviour, low inventory sensitivity,and differences in average purchase rates amongconsumers (see Blattberg et al. 1995).

Academics and practitioners have increasinglyrecognized the potentially harmful impact ofprice discounts on product image and price sensi-tivity. Price promotions may have a negative impact on the buyer’s (future) attitude towardsthe brand, when he starts attributing his purchasemotivation to the promotion instead of to a likingfor the brand (self-perception theory). Frequentprice cuts may also enhance deal-to-deal buying,as consumers learn to anticipate future price cuts(Blattberg and Neslin 1989). Finally, as suggestedSection 4.1.2 on psychological pricing, frequentpromotions may reduce consumers’ willingness topay through their impact on reference prices (seee.g. Folkes and Wheat 1995).

8.1.2 Implications beyond promoted item

Price cuts clearly have implications beyond theitem that is promoted. In the short run, there isoverwhelming evidence of switching from otheritems to the one on promotion. If customers aredrawn away from other company items, this results in cannibalization; otherwise sales are‘reaped away’ from competitors. Price discountson one item may also positively affect sales ofcomplementary items. According to Blattberg et al. (1995), the magnitude of such cross-effectsvaries with the product category. The profitabilityof price promotions for retailers depends on theirtraffic-building effect (Walters and McKenzie1988). While it seems logical that advertised pro-motions can result in increased store traffic andinterstore switching, the evidence is mixed and,once again, probably highly category specific (seeBlattberg et al. 1995). In the long run, price dis-counts can be used as an entry-deterring deviceand increase store competitiveness. The impact ofprice discounts on store image is not unravelledyet. While price discounts may signal low pricesoverall, they may also harm store credibility andcreate a cheap image. In their review on price-promotion effects, Blattberg et al. (1995) concludethat little is known about how price promotionsshape store image.

� ‘Sales promotion is a marketing com-munication technique where additional

incentives beyond the inherent qualities or ben-efits of the product or service are offered to thetarget audience, sales force, or distributors. Thisis achieved by, for instance, temporarily modify-ing the price relative to that of the competitors.’(Chapter 12, p. 282)

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The potential negative effects of price discountshave led some academics and practitioners to believe that promotions have been overused. Thereturn to EDLP strategies by retailers and somemanufacturers, as for instance, Proctor & Gamble,could be a response to the less desirable impacts ofprice promotions just outlined.

In summary, the impact of manufacturer and re-tailer promotions is complex. Price discounts operate at different levels and in different periods.Their effect depends on many factors. Crucial de-terminants are product category characteristics,such as category penetration, perishability andability to stockpile, length of the purchase cycle,and novelty. Consumer characteristics such as variety-seeking tendency, consumer perceptions,economics of time, consumer attitude, and loyaltyshape deal proneness. In addition, the competitivepromotion environment and a company’s ownpromotion conditions such as promotion fre-quency, depth, timing, instrument, and way ofcommunication have a major effect on promotionoutcomes. For retailers, supply characteristicssuch as retail margins, depth and frequency ofmanufacturer deals, retail inventory, and retagg-ing costs further complicate promotion effectsand decisions (Tellis and Zufryden 1995).

8.2 Trade promotionsLal, Little, and Villas-Boas (1996) define trade pro-motions as ‘temporary price reductions offered bymanufacturers to retailers for the purpose ofstimulating sales’. Following these authors, tradepromotional spending has exceeded advertisingspending in much of the consumer packagedgoods industry. Many reasons have been put for-ward to explain this phenomenon. While the logicbehind trade promotions may be similar to that forconsumer and retail promotions (for example,they may appeal to the deal-prone final consumersegment, limit the competitive threat fromsmaller and private label brands, and so on), it is in-creasingly believed that a specific explanation ofthe success of trade deals should take the point ofview of the retailers into account. Ultimately, it isthey who decide to accept or reject trade deals.

The belief that trade deals cannot be solely justi-fied on the basis of ultimate consumer reactions issupported by observed retailer reactions to tradedeals. First, various studies have demonstratedthat retailers may forward buy in response totrade promotions, and engage in deal-to-deal buy-ing (see e.g. Blattberg et al. 1995; Lal et al. 1996). Sec-

ondly, having profited from a trade deal, retailerstypically pass through less than 100 per cent of thedeals (Blattberg et al. 1995). As a result, consumersales usually increase but not as much as retailersforward buy, as can be judged from troughs inmanufacturer shipments after the deal (see alsoBlattberg and Neslin 1989). Lal et al. (1996) sum-marize this as follows: ‘Retailers regularly take advantage of trade deals to stock up with extragoods: they engage in forward buying. This leadsto decreased margins for manufacturers on largeamounts of goods, often not made up for by in-creased sales to ultimate customers as a result ofmerchandising. Hence, manufacturers report thatmany trade deals are not profitable.’

On top of these seemingly limited positive saleseffects, offering trade deals implies ‘transactioncosts’ to manufacturers. Costs of preparing andimplementing trade deals encompass costs of thesales force promoting the deal to retailers, and ofthe development of sales support material (Blatt-berg and Neslin 1989). Also, retailer forward buy-ing creates logistical dysfunctions, which shedsanother shadow on the attractiveness of tradedeals.

Justifications for trade deals should thus find ar-guments beyond final consumers’ reactions. Oneargument is that trade deals are needed to appealto ‘warehouse store channels’. These warehousechains exclusively purchase merchandise on deal,and are in a sense comparable to the deal-proneconsumer segment.

Another justification is developed by Lal et al.(1996), who argue that managers use trade deals tosecure sufficient shelf space and POP support (fea-tures, displays) for their products at the retaillevel. These authors observe that many trade dealsare offered with ‘performance clauses’: the manu-facturer offers to reduce wholesale price for a certain period—say, 6 weeks—in return for the re-tailer running a prespecified kind of merchandis-ing during, say, at least one week of the period.Many manufacturers use trade promotions to ob-tain displays and features—price is not the wholestory. Within this context retailers may or may notaccept a trade-deal offer from a manufacturer. Ifthey do not accept, purchases are made at the reg-ular (non-deal) price. If they do accept, they arebound by the Cooperative Purchase Agreement,and receive payment only upon receipt of the cer-tificate of performance by the manufacturer. Onceaccepted, trade deals usually lead to non-zero pass-through because they make features and displays


more effective (Lal et al. 1996). In brief, followingthis reasoning, manufacturers use trade deals to‘be in the retailers’ inventory’. These deals mayimply extra sales as a result of the displays, fea-tures, and pass-through, but this is not their soleadvantage. The authors suggest that, besides thesales-generating effect to ultimate consumers inthe given competitive setting, trade deals mayimply more favourable competitive environmentsfor manufacturers. This is true because retailerscan accept only a limited number of trade dealsfrom manufacturers. The latter cannot offer tradedeals all the time because of transaction costs. Fol-lowing Lal et al. (1996), this leads to a system ofchannel interactions that softens the intensity ofcompetition between manufacturers. Other au-thors have studied ‘optimal’ or prevailing retailerreactions in the presence of trade deals empiri-cally. These studies reveal that retailer pass-through depends on deal depth, the normalmargin, the response of ultimate customers, andthe choice of promotion instrument (see e.g.Greenleaf 1995).

In brief, trade promotions have been increas-ingly used by manufacturers as a marketing tool.While the rationale behind trade promotions maypartly be based on ultimate consumer reactionsand the attempt to increase ultimate sales, retailerreactions to trade deals (forward buying, limitedpass-through) and the observation that net long-term sales effects remain small have cast somedoubt on the effectiveness of this instrument. De-spite additional advantages, such as securing shelfspace and promotion support, some of this doubtremains in a number of categories. In planningtrade promotions, manufacturers should at leasttake retailer reactions into account, or take ap-propriate counter-actions to discourage forwardbuying.

9 The future

Because of a wide range of factors such as increasing competition, rising costs (putting

higher pressure on margins), and better availabil-ity of information to consumers, pricing is boundto become an even more important decision in thefuture.

The polarization typical of many Western soci-eties (where people become more heterogeneousin wealth, education, and availability of time)

makes it more and more crucial to account forconsumer heterogeneity in reactions to price.Price customization, or charging differentialprices to various segments, is gaining way. At thesame time, companies should be aware of therisks and costs involved in such customization.Appropriate differential pricing is more costly anddifficult to implement and control, and compan-ies should ensure they apply their price strat-egy systematically. Also, customization requiresinsights into the price sensitivity of different segments. Measuring this price sensitivity will be-come even more important than it is at present.This measurement will be facilitated by the avail-ability of external data sources like scanner(panel) information, or necessitate managementof customer databases by the company. The chal-lenge becomes, not to find data, but to extractrelevant information on price sensitivity fromthose huge databases.

Technological developments will continue toput their mark on pricing decisions in a variety ofways. Electronic shopping (for example, shoppingover the Internet) will increase the accessibility ofprice information to customers (see Insert). It willalso reduce the potential for geographically dif-ferentiated prices in a number of product cate-gories. Technological advances are bound tofurther shorten product life cycles. This enhancesthe importance of establishing the right pricestrategy from the start (quick and sound price de-cisions), but also calls for a long-term perspective,where managers must anticipate the impact oftheir current prices on future own and competi-tive product versions.

pricing 239

may become weary of deals and more alert to potential deception in price promotions. Time-based price strategies other than promotions maytrigger similar customer reactions. The attractive-ness of these strategies should thus be regularlyre-evaluated.

The future is likely to give more attention tochannel pricing. Retailers are bound to becomemore active price-setters vis-à-vis final consumers,and more powerful negotiators in discussionswith manufacturers. Issues in retailer pricing thathave been neglected—such as the impact of priceson category or store profit as a whole, and the linkbetween prices and store image or store traffic—are likely to become prime areas of attention. Atthe same time, negotiation skills will become amore important asset to all channel members.

International pricing will also stay a viable re-search area in the years to come. Markets will con-tinue to open up and more strongly depend onone another; customers will tend to become in-creasingly ‘mobile’ and/or better informed aboutprices in an international setting; legal and traderestrictions are bound to be adapted and regula-tions made more uniform. It is obvious that theseevolutions will affect opportunities for profitablepricing. Companies that ‘master’ internationalpricing techniques, and have access to informa-tion systems keeping them up to date, have abrighter future ahead of them.

10 Summary

While a company’s product, distribution, andadvertising decisions are crucial factors de-

termining the product’s overall attractiveness, ef-fective pricing is essential to turn these assets intoprofit. Effective pricing requires a systematic ap-proach, starting with a thorough analysis of thewide variety of environmental factors that may affect a company’s pricing decisions and results.Next, strategic pricing objectives and operationalpricing goals have to be selected. Pricing objec-tives need to be in correspondence with overallcompany objectives and should focus on the possi-bilities uncovered by the environmental analysis.In this way, pricing objectives set the stage for selection of appropriate pricing strategies. Theessence of profitable pricing is indeed to select apricing strategy that exploits the opportunities offered by customer heterogeneity, competitive

Price comparisons via the Internet

‘Shopping “agents” such as Netbot’s Jango can mimica megastore by searching across many stand-alonestores for a product at the cheapest price.’Source: The Economist, 11 Nov. 1997, 100.

Even in settings that are not high tech, dynam-ics in consumer reactions should be carefullymonitored. The long-term implications of pricestrategies are still under-researched, and man-agers should be aware of shifts in customer reac-tions that may result from frequent adoption ofcertain strategies. Increased use of promotionsmay enhance customer price sensitivity or lead tomore price anticipation. Conversely, consumers

position, product characteristics, or a combina-tion of these (Tellis 1986). Successful implementa-tion of the pricing strategy requires selection of an appropriate price structure and regular price levels, and the planning of short-term variationsaround these levels. Several methods are availablethat can help to narrow down the range of feasibleprice levels within which a regular price has to beselected. Yet, as a result of the multitude of influ-encing factors, imperfect or partial information,and product- and situation-specific effects, thepricing problem is in most cases too complex toderive optimal prices in a single round. Instead,managers should learn to assemble ‘bits andpieces’ of information and insights to arrive at appropriate prices. More information and betterinsight into the pricing problem can be acquiredgradually, allowing managers to improve theirpricing decisions over time. Besides this learningprocess, the continuously changing environmentand evolution in pricing objectives over the PLCrequire that—even for existing products—pricesbe evaluated at regular intervals and adjusted ifnecessary (Keegan 1995).

Further readingBlattberg, R., and Neslin, S. A. (1990), Sales Promotion:

Concepts, Methods and Strategies (Englewood Cliffs, NJ:Prentice Hall). This book provides an in-depthdiscussion of various short-term pricing actions andtheir implications. Consumer and retailer, as well astrade promotions, are dealt with.

Dolan, R., and Simon, H. (1996), Power Pricing: HowManaging Price Transforms the Bottom Line (New York:Free Press). This book emphasizes the opportunitiesoffered by strategic pricing. Particular attention is paidto ‘price customization’, or the adoption of ‘demand-oriented’ and ‘differential’ pricing strategies. The bookalso provides interesting insights in and checklists forthe implementation of price decisions.

Gijsbrechts, E. (1993), ‘Prices and Pricing Research inConsumer Marketing: Some Recent Developments’,International Journal of Research in Marketing, 10/2:115–51. This paper provides a review of developments inthe literature on consumer pricing after 1985, andindicates directions for further research.

Monroe, K. (1990), Pricing: Making Profitable Decisions(New York: McGraw Hill). This textbook provides asystematic analysis of the different pricing aspects. It isfairly complete and encyclopaedic in nature.


Nagle, T. T., and Holden, R. K. (1995), The Strategy andTactics of Pricing: A Guide to Profitable Decision Making(Englewood Cliffs, NJ: Prentice Hall). This book is notintended as a textbook, but rather as a guide formanagers. It is organized around major pricingissues/questions encountered in practice, andillustrates the strategic importance of pricing.

Tellis, G. J. (1986), ‘Beyond the Many Faces of Price: AnIntegration of Pricing Strategies’. Journal of Marketing,50/4 (Oct.), 146–60. This article provides an interestingtaxonomy of pricing strategies. It discusses theconditions under which these strategies can beprofitable, and provides examples and various forms ofthe generic strategies.

Discussion questions1 The contemporary definition of price goes beyond‘the monetary effort to obtain one unit of the product’.How is the price concept broadened, and what are theimplications for pricing?

2 Using a systematic approach to pricing allowsmanagers to respond quickly and effectively toenvironmental changes. Discuss.

3 Discuss the factors that have a major impact onaggregate price–volume relationships, and illustratewith an example.

4 Customer reference prices play a major role in avariety of buying situations. In what way are theyrelevant for managers in charge of pricing?

5 Why is there less knowledge on price sensitivity inindustrial markets than in consumer markets?

6 Competitive interrelationships and channelinteractions affect a company’s optimal pricing policy.What are the differences and similarities between bothtypes of interactions in view of pricing?

7 The strength and weakness of Tellis’s taxonomy is thatit discusses and positions generic pricing strategies.Discuss.

8 What are the differences between randomdiscounting, second-market discounting, andadvertised discounting? Under what conditions willthese strategies be profitable?

9 Discuss generic pricing strategies likely to be used by(i) a company operating in an international market, (ii) aretailer, (iii) a not-for-profit company.

10 Complex price structures exploit marketopportunities, but they also entail costs. Discuss andillustrate.

11 Short-term price cuts may be part of a pricingstrategy, or serve operational purposes. Discuss.

12 In deciding upon their trade promotion activities,manufacturers should anticipate retailer reactions.Discuss.

13 There is no single best method for determiningoptimal price levels. Instead, managers should use acombination of rules, and qualitative as well asquantitative information, to develop relevant priceboundaries. Discuss.

pricing 241

On 12 April 1992, at 9 p.m., Walt Disney Co. opened its EuroDisney theme park in Marne-la-Vallée in France, approxi-mately 30 kilometres east of Paris. Euro Disney—now re-ferred to as Disneyland Paris—was the fourth Disneytheme park in the World, next to Disneyland in California,Disneyworld in Florida, and Disneyland Tokyo. Its conceptwas identical to that of Disney’s US theme parks, whichcreate a complete ‘fantasy’ world where client orientationis of primary importance. The Euro Disney theme park, onits opening day, covered fifty-six hectares of land offeringtwenty-nine attractions. The total Euro disney resort further comprised golf courses, parks, a camping and en-tertainment centre, six hotels, thirty-two stores, andtwenty-nine food outlets. Total investment was estimatedat approximately FFr. 30 billion. The Walt Disney Co.owned 49 per cent of Euro Disney, the remaining capitalcoming from banks and other investors. Euro Disneyplanned on starting up the second phase by 1993, duringwhich time Disney-MGM studios would be built. Onlyminor adaptations were made to adapt the Disney ThemePark to European taste and conditions. The Theme Parkpersonnel—referred to as ‘Cast Members’—were re-quired to be multilingual (they should speak English andFrench, but preferably also other European languages),such that all visitors could be served in their mothertongue. Many of the personnel had been recruited fromNorth European countries. The number of attractions in-volving language was kept at a minimum, and the fairytales that were emphasized catered to European tastesand background. The infrastructure was adapted to European weather conditions, and brighter costumeswere used to give the park a lively atmosphere even whenthere was no sun. Euro Disney counted on attracting visi-tors in all age categories, and—given its accessibility—from a range of European countries. The price for a dayticket was set at FFr. 225 per adult; children between 3 and11 were charged FFr. 150. The minimum rate for a night atone of Disney’s theme hotels amounted to FFr. 450 perperson. Despite these premium prices (ticket prices wereabout two to three times higher than those of other European theme parks), Euro Disney did not fear the competition of other European attraction parks, whichwere smaller, closed during the winter season, and used adifferent concept. Convinced that the Disney label wouldsell itself, the company spent little on advertising, yetcounted on 11 million visitors during the first year of opera-tion. About half of these visitors were expected to beFrench. Foreign visitors were forecast to spend about FFr. 6.6 billion yearly in the theme park.

While there was great enthusiasm in France andthroughout Europe, some criticisms emerged even beforethe park opened its doors. A number of observers postu-lated that entrance tickets were too expensive, and thatEuropeans might be less seduced by the overly friendlyand humble ‘American’ style of the cast members. Othersemphasized that Euro Disney management had underesti-mated the seasonal patterns of theme-park attendance inEurope.

12 April to 1 October 1992After approximately six months of operation, Euro Dis-ney’s results were disappointing. The revenues of FFr. 1,501billion during the first quarter were below expectations,and by 1 October, the end of the fiscal year, a considerableloss (various sources indicated losses ranging from FFr. 188to 339 million) was recorded. While the number of Englishand German visitors was in line with the original objec-tives, attendance by the French was surprisingly low, andaccounted for only 29 per cent of all visitors. The targetlevel of 11 million visitors during the first year seemedthreatened. Euro Disney management reacted to these re-sults by lowering the ticket prices for the local populationfrom FFr. 225 to FFr. 150. In addition, reduced group rateswere offered to the French during the down season. Theselocal price adaptations were accompanied by intense advertising campaigns, and personal selling effort ad-dressed at French schools and companies. Yet, Eisner (the president of the Walt Disney Corporation) empha-sized that these price changes were in line with US prac-tices of offering low prices to locals (local inhabitants payabout $20 for a Disneyland ticket in Anaheim), and wereby no means an indication that tickets were generally tooexpensive.

1 October 1992 to 30 March 1993By March 1993 Euro Disney announced that it had reachedthe target of 11 million visitors during the first year of operation. Yet, the improved attendance was largely theresult of its focus on the French market. This increased local interest, however, created new problems. Frenchvisitors were less likely to spend a lot on food and mer-chandising, and made less use of hotel infrastructure.Also, demand was much more seasonal than expected at first. Both the local recruitment and the seasonal diptranslated into poor results. Hotel occupancy ratesdropped from 74 per cent in the first six months of op-eration to less than 40 per cent from October to the end of March. The total number of visitors during the latter period hardly reached 3.3 million, and the return of FFr.1.79 billion they generated was below expectations. It is estimated that between the beginning of October to the end of March, Euro Disney incurred a loss of FFr. 1.08billion.

In an attempt to ‘turn the tide’, managers quickly

Mini CaseEuro Disney

responded with a number of marketing changes. First, theprice structure was adapted to account for seasonality indemand. One-day ticket prices for the period Novemberto February (excluding Christmas) were reduced to FFr. 175per adult and FFr. 125 per child. This decrease was compen-sated for by higher prices for the summer and Christmasperiods, during which adults paid FFr. 250 and childrenwere charged FFr. 175 for a one-day passport. In the in-between periods, the original ticket prices of FFr. 225(adult) and FFr. 150 (child) were sustained. Prices for foodand souvenirs were equally reduced. Visitors to the themepark complained that waiting lines were too long (waitingfor an hour and a half for one attraction was not excep-tional), and that the number of attractions was too limitedto justify spending two days or longer at the park. In reac-tion to this, Disney management offered reduced en-trance rates for visitors coming into the park after 5 p.m. Italso announced its plans to open up six new attractions inthe near future, in order to encourage longer stays or mul-tiple visits. Further in line with this objective, hotel rateswere reduced (the cheapest hotel was now available forFFr. 300 per night, and children were allowed to stay forfree), and annual passports (covering eleven visits) wereoffered at lower rates per visit.

An additional problem arose as aresult of different eat-ing habits in Europe compared to the USA. While Americans tend to nibble all day, or are prepared to havetheir meals between 11.30 a.m. and 3 p.m., Europeanswant to have lunch between 12 a.m. and 2 p.m. This re-sulted in long waiting lines at the restaurants, especiallysince the six classical establishments where one could sitdown and eat at ease were less favoured by visitors. Man-agement, therefore, changed the biggest classical restau-rant into a fast-food eating location. In addition, Disney’scomplete ban on alcoholic drinks in the theme park, whichwas badly received by Europeans, was relieved: from May1993 visitors could consume French and Californian winesin the restaurants.

Given its tight financial situation, the company also feltcompelled to slim down the cost of its operations. Person-nel cost was significantly lowered by using more flexibleand part-time cast members, and by reducing the numberof employees from 19,000 in the peak to 10,000 in thedown-season periods. Plans for the second phase of thetheme park were put on hold.

1 April 1993 to 30 September 1994Despite the adaptations in marketing approach, the com-pany did not crawl out of its unsound financial situation.Between 1 April and 30 June 1993 only 3.1 million visitorswere attracted, and there was a strong fall in foreign at-tendance, especially from UK and Italian visitors. Accord-ing to managers and outside observers, the generalrecession and the strength of the French franc (comparedto the UK pound or Italian lira) partly accounted for this.

mini case: euro disney 243

Hotel occupancy rates were reasonable (68.5 per cent),but this was probably the result of hotel rate reductions;and the overall return of FFr. 1.456 billion was disappoint-ing. The situation became worse in the months that fol-lowed. While the number of visitors still reached 6.7million from 2 July to 30 September, attendance figuresand spending levels per visitor further decreased in themonths after. The many changes in marketing approachhad not yielded the anticipated success, and Euro Disneyhad to find a settlement with the Walt Disney Company.With a total debt of FFr. 20.3 billion by the end of 1993, EuroDisney was close to bankruptcy, and a financial restructur-ing was needed.

Multiple criticisms of Euro Disney’s marketing approachappeared in the international press, and Euro Disney wasblamed for being ‘arrogant’ in imposing its own way ofdoing business on the Europeans. On the distribution side,this resulted in unsatisfactory relationships with Europeantour operators. Critics also postulated that ticket priceswere still too high, especially if repeat visits were to be en-couraged—a necessity for becoming profitable. Otherssuggest that price schemes should become more complexto differentiate between days of the week, and that hotelrates should be further reduced to meet competition fromParisian hotels. Finally, the number of attractions (thirty-five compared to fifty-five in Disneyland California) wasstill deemed too low to lead to long stays and repeat visits.During the first nine months of 1994, the number of visi-tors hardly reached 8.2 million, and these visitors keptspending too little and did not return for repeat visits. Bythe end of September 1994 Euro Disney closed the fiscalyear with a loss of FFr. 18 billion, and a total of only 8.8 mil-lion visitors. Clearly, the company had seriously to rethinkits strategy.

A new ElanIn December 1994 Euro Disney’s top manager PhilippeBourguignon announced further revisions of the themepark’s pricing scheme. In order to escape from the nega-tive spiral of low visit frequency and spending level of visi-tors, the company decided (again) drastically to reduce itsentrance prices from 1 April 1995 on, and simplify the pricestructure. In the new pricing scheme, the price for an adultone-day passport dropped from FFr. 250 to FFr. 195 duringthe peak season (1 April to 30 September), and from FFr.175 to FFr. 150 in the down season (1 October to 31 March);the in-between season tariff no longer applied. FollowingBourguignon’s announcement, the price of FFr. 250 con-stituted a psychological barrier for visitors. Rates for chil-dren were adapted accordingly: to FFr. 150 in the peakseason, and to FFr. 120 otherwise. Two- and three-daypassports were still offered at slightly lower rates, andlocal inhabitants continued to receive special reductions.As tickets constituted only part of total return, it was esti-mated that the break-even increase in number of visitors

(needed to compensate for the price reductions) camedown to only 700,000 visitors.

During the first half of 1995 the number of visitors in-creased, and returns rose by 7 per cent. The company stillincurred a loss, but this was less considerable than hadbeen expected, partly as a result of the financial restruc-turing during 1994 (reduced royalty payments to the WaltDisney Co., and to postponed interest payments to thebanks). By the end of the fiscal year 1994/5, the companyfinally came out of the ‘red figures’: a profit of FFr. 114 mil-lion was noted.

By July 1995 the company opened up five more attrac-tions, leading to a total of forty attractions in the themepark. Disneyland Paris, as it is now called, was slowly com-ing out of its disastrous position. From 1 October 1995 to 31December 1995, losses were kept down to FFr. 57 million(about half the figure for the same period in the previousyear). Yet, the company refrained from becoming overlyoptimistic. The reductions in ticket prices had increasedthe number of visitors by about 21 per cent, but the returnsfell somewhat behind, with an increase of only 10 per cent.A crucial point of concern remained the low spending levels of visitors in the theme park. Also, the evolution ofexchange rates was still to Disney’s disadvantage.

EpilogueIn 1997 Disneyland Paris celebrated five years’ of existence.While it would be an exaggeration to speak of a real up-swing, the company was certainly improving its position.The fiscal year 1995/6 ended with a profit of about FFr. 197 million. About 11.7 million visitors visited the theme parkduring 1996—a million more than the year before. In total, about 50 million visitors had crossed the entrancegate since the opening in April 1992. (While French par-ticipation was obviously still dominant, the Benelux countries were now in second position and accounted for19 per cent of all visitors.) Occupancy rates had also in-creased, from a level of 68.5 per cent in 1995 to 72 per centin 1996.

In January 1997 Eric-Paul Dijkhuizen, General Director ofDisneyland Paris for the Benelux countries, stated: ‘Wehave made some beginners’ mistakes. While the Park was originally conceived as a holiday destination, we nowposition it as a “trip” comparable to a weekend to Londonor Paris.’ By then waiting times in the park had droppedsignificantly—for top attractions like the Space Mountainthey had been reduced by half (from 1.5 hours down toforty-five minutes) and Euro Disney made sure that its vis-itors were entertained while waiting. In the course of 1997the company plans to open up a new cinema complexGaumont in Disney Village, with eight theatres offeringseats for 2,500 visitors. In 1997 Disneyland Paris celebratedits fifth birthday.

Sources: Euro Disney; De Financieel Economische Tijd, 28 Apr. 1993,12 Oct. 1994, 15 Dec. 1994, 13 Mar. 1996; Financial Times, 12 Apr.


1992, 9 July 1993; Gazet van Antwerpen, 10 May 1997; Tijdschrift voorMarketing, Mar. 1992; Trends, 9 Jan. 1997.

Question and exercise

Critically examine Disney’s pricing strategy in the contextof the discussion of ‘The meaning of price’ in Section 1.1.

Business

Pricing of a product