Setting the Right Price Answer Key

SetÝng the Right Price Final exam questions 101. Refer to the scenario. What pricing practice was used to price the plastic storage boxes? a. seasonal pricing b. price shading c. price lining d. cumulative pricing ANSWER:c 102. Refer to the scenario. Which pricing tactic was Michael’s probably using with its Funky Girls Gel Pens? a. seasonal pricing b. price lining c. price bundling d. loss leader pricing ANSWER:d 103. Refer to the scenario. What pricing practice was used with the scrapbook starter kit? a. psychological pricing b. price lining c. price bundling d. leader pricing ANSWER:c 104. The first step in setÝng the right price for a new product is to estimate demand, costs, and profits. a. True b. False ANSWER:False 105. All pricing goals have trade-offs that managers must weigh. a. True 1 b. False ANSWER:True 106. Once the owner of a cleaning service puts together information on pricing objectives, market demand, quantity supplied, and the price elasticity of demand, he will be ready to determine the optimal price for a new service offering. a. True b. False ANSWER:False 107. Profit maximization means setÝng prices so that total revenue is as large as possible relative to total costs. a. True b. False ANSWER:True 108. It makes the most sense to use price skimming as a pricing policy when supply is greater than demand. a. True b. False ANSWER:False 109. Penetration pricing is sometimes referred to as a “market-plus” approach to pricing. a. True b. False ANSWER:False 110. The Raver-Smythe Corporation (RSC) has introduced mylar-based artificial fingernails. It earns a low profit margin on the sale of each box of its new fingernails and is still able to meet its revenue objectives due to economies of scale. RSC is using a penetration pricing policy. a. True b. False ANSWER:True 111. One disadvantage of using a penetration pricing policy is that the high unit profit margins will attract potential competitors into production of similar products. a. True b. False ANSWER:False 2 112. There are two limousine services that drive customers from communities in Winnipeg to the airport. Whenever one reduces its fare, its competitor reduces its fares by the same amount. This is an example of status quo pricing. a. True b. False ANSWER:True 113. Manufacturers know the approximate price level they can expect when establishing a product price. This approximate price is called the base price. a. True b. False ANSWER:True 114. One of the advantages of penetration pricing is that it can make it difÏcult for the competition to compete. a. True b. False ANSWER:True 115. Functional discounts are typically calculated as the wholesale price times the accumulated margin percentages. a. True b. False ANSWER:False 116. Hudson owns a company that installs in-ground swimming pools. He gives large discounts to homeowners who have pools built in October or November. This is an example of a seasonal discount. a. True b. False ANSWER:True 117. Functional discounts, noncumulative quantity discounts, and promotional allowances are examples of rebates given to the trade customer. a. True b. False ANSWER:False 118. The basic idea with price skimming is that the firm is customer driven, and seeks to understand the 3 attributes customers want in goods and services they buy and the value of that bundle of attributes to customers. a. True b. False ANSWER:False 119. Evergreen Lighting, a manufacturer of decorative, energy-efÏcient lighting products, requires its buyers to pay for the cost of transportation from the manufacturing site to their place of businesses. Evergreen Lighting uses FOB origin pricing. a. True b. False ANSWER:True 120. A manufacturer using uniform delivered pricing is legally discriminating against buyers who are located close to the point of shipping because they pay the same amount as buyers located far from the point of shipping. a. True b. False ANSWER:True 121. A retail store implements a single-pricing tactic as a way to remove price comparisons from the buyer’s decision-making process. a. True b. False ANSWER:True 122. A catalogue retailer offers three styles of khaki pants at three price levels. Customers can buy khaki pants for $26, $32, or $38 and at no other prices but these. The special pricing tactic used by the catalogue retailer is best described as variable psychological pricing. a. True b. False ANSWER:False 123. Charlene’s cable system has offered her a deal for basic cable plus six premium channels for less than she is currently paying for basic cable. The cable system is using price lining to increase its overall profits. a. True b. False ANSWER:False 4 124. One example of price bundling occurs when the ballet sells season tickets at a lower price than the total price of tickets for each show bought individually. a. True b. False ANSWER:True 125. Many businesses find recessions to be an excellent time to build market share through the use of price bundling. a. True b. False ANSWER:True 126. Two-part pricing means charging two separate amounts for the service and tangible product elements. a. True b. False ANSWER:False 127. Bait pricing is a price tactic that tries to get the consumer into a store through false or misleading price advertising and then uses high-pressure selling to persuade the consumer to buy more expensive merchandise. a. True b. False ANSWER:True 128. Price fixing is clearly illegal in all instances. a. True b. False ANSWER:True 129. Price discrimination can sometimes be justified. a. True b. False ANSWER:True 130. A winery that makes a huge profit on merlot wines may lower its price on pinot noir wines to cause damage to wineries that produce only pinot noir. This is an example of predatory pricing. a. True b. False 5 ANSWER:True 131. List in order the four steps used to set the right price for a product. ANSWER:1. Establish pricing objectives. 2. Estimate demand, costs, and profits. 3. Choose a price strategy to help determine a base price. 4. Fine-tune the base price with pricing tactics. 132. Two reasons are given to explain why some companies price their products too low, thereby reducing company profits. What are they? ANSWER:First, managers attempt to buy market share through aggressive pricing. Usually, these price cuts are quickly met by competitors. Thus, any gain in market share is short lived, and overall industry profits end up falling. Second, managers have a natural tendency to make decisions that can be justified objectively. Managers, however, often lack the hard data needed to make an accurate assessment of the market and what pricing strategy should be used. Managers tend to make pricing decisions based on easily gathered, short-term focused information, such as costs, sales, market share, and competitors’ prices rather than on long-term profitability. 133. What activities occur once the marketing manager has established pricing goals? Why are these activities important? ANSWER:The marketing manager must first estimate quantity demand levels and elasticity of demand, which allows for an estimate of revenues at a variety of price levels. Next, corresponding costs should be determined for each price. Then the manager can estimate the amount of profit and market share that can be earned at each possible price. Alternative pricing policies can be examined in terms of revenues, costs, and profits. This information becomes the core of the price policy by determining which price can best meet the firm’s pricing goals. 134. What are the three basic strategies for setÝng a price on a new good or service? Briefly describe each strategy. ANSWER:Priceskimming: With this method, a high introductory price is charged that skims the top off a market in which there is greater demand than supply. The high introductory price attracts a smaller market share but recoups costs quickly. Penetrationpricing: With this method, a firm charges a relatively low price, hoping to reach the mass market in the early stages of the product life cycle. The low price allows the product to penetrate a large portion of the market, resulting in large market share and lower production costs. Statusquopricing: With this method, price is set identical or close to that of the competition. This strategy may be used more often by small firms for survival or ease of use but ignores demand and cost. 6 135. Under what conditions is each of the three basic pricing methods successful? ANSWER:Price skimming is successful when (1) demand is greater than supply; (2) there are barriers to competitive entry, such as legal protection or technological breakthroughs; (3) production cannot be expanded rapidly; and (4) customers perceive a high value for the product. Penetration pricing is successful when (1) the market is price sensitive, (2) economies of mass production are feasible, and (3) the firm has substantial resources to sustain the short-run losses necessary to obtain penetration. Status quo pricing can be successful when (1) the firm is comparatively small, and (2) the firm needs a safe route to long-term survival. 136. List the three basic pricing methods. Name one advantage and one disadvantage associated with each. ANSWER:Price-skimming advantages include (1) quick recovery of product development or educational costs, (2) pricing flexibility that allows subsequent lowering of price, and (3) the ability to market prestige products successfully. Disadvantages include encouragement of competitive entry into the market. Penetrationpricing advantages include (1) a tendency to discourage competitive entry, (2) large market share due to high volume sold, and (3) lower production costs resulting from economies of scale. Disadvantages include (1) lower profits per unit, (2) higher volume required to reach the break-even point, (3) slow recovery of development costs, and (4) inability to later raise prices. Statusquo policies have the advantage of simplicity. Disadvantages include ignoring demand and cost. 137. Which pricing method (skimming, penetration, or status quo) would be most appropriate for each of the following products: (1) a new kind of automatic vacuum cleaner, (2) brightly coloured wooden blocks to be used as a child’s toy, (3) a new, low-cost, no-calorie fat substitute, (4) a home computer, and (5) a designer perfume. Briefly justify your answers. ANSWER:Vacuumcleaner: Skimming could be used, because there are innovators and early adopters who would like to be “first” to own the product. It is likely that competition could also follow fairly quickly, further justifying a skimming policy. Child’sblocks: Status quo pricing could be used, because this type of toy is a mature product with many substitutes. Penetration pricing could be argued if one assumes the producer found manufacturing cost advantages. Fatsubstitute: Penetration pricing would quickly gain a large market share and is appropriate for a low-cost item. Skimming could be argued if one assumes greater demand than supply for the product. 7 Homecomputer: Penetration pricing is appropriate because of the large amount of competition in this particular market. Perfume: Skimming would be appropriate, because a lower introductory price might reduce the high-prestige perception of the product. 138. A base price may be lowered through the use of a discount. Discounts take a variety of forms and have several different objectives. Name and define three types of discounts (do not include allowances or rebates). State the main objective of the each type of discount you identify. ANSWER:Quantitydiscounts are offered to buyers who purchase multiple units or above a specified dollar amount. The objectives of the quantity discount include selling large volumes and encouraging customer loyalty (through cumulative quantity discounts). Cashdiscounts are price reductions offered to buyers who pay promptly. One objective is to save the seller carrying charges, billing expenses, and expenses associated with extending credit. Another objective is to avoid bad debt. Functional(ortrade)discounts are compensation to wholesalers and retailers for performing channel functions. The objective is to compensate the channel member for services rendered or to encourage additional functions to be performed by the trade. Seasonaldiscounts are price reductions for buying merchandise out of season. The objectives of seasonal discounts include shifting the storage function forward to the purchaser and enabling a steady manufacturing schedule. 139. Distinguish between a cumulative and a noncumulative discount. ANSWER:A cumulativequantitydiscount is a deduction from list price that applies to the buyer’s total purchases made during a specific period and is intended to encourage customer loyalty. A noncumulativequantitydiscount is a deduction from list price that applies to a single order and is intended to encourage orders in large quantities. 140. What is value-based pricing? What is the basic assumption marketers must make about their markets before implementing a value-based pricing strategy? ANSWER:Value-based pricing is a pricing strategy that has grown out of the quality movement. Instead of figuring prices based on costs or competitors’ prices, it starts with the customers, considers the competition, and then determines the appropriate price. The basic assumption is that the firm is customer driven, seeking to understand the attributes customers want in the goods and services they buy and the value of that bundle of attributes to customers. 141. Geographically dispersed sellers often result in significant freight costs. Define four types of geographic pricing tactics that can be selected by a marketing manager to moderate the impact of freight costs on its more dispersed customers. For each tactic defined, specify the circumstances that would prompt the selection of that geographic pricing tactic. ANSWER:FOBoriginpricing: This price tactic requires the purchaser to pay for the cost of transportation from the shipping point. A manager would choose to use FOB origin pricing if 8 he or she is not concerned about total costs varying among the firms’ clients or if freight charges are not a significant pricing variable. Uniformdeliveredpricing: With this price tactic, the seller pays the actual freight charges, but bills every buyer an identical, flat freight charge. This equalizes the total cost of the product for all buyers, regardless of location. A manager would select this policy if the firm is trying to maintain a nationally advertised price or when transportation charges are a minor part of total costs. Zonepricing: This price tactic is a modification of uniform delivered pricing in which the geographic selling area is divided into zones. A flat freight rate is charged to all customers in a given zone, but different rates will apply to each zone. A marketing manager would use this strategy to equalize total costs among purchasers within large geographic areas. Freightabsorptionpricing: With this price tactic, the seller pays all or part of the actual freight charges and does not pass these charges along to the customer. A manager would choose this tactic if competition is extremely intense or if the firm is trying to break into new market areas. Basing-pointpricing: This method requires the seller to designate a location as a basing point and charge all purchasers the freight cost from that point (regardless of the point from which the goods are actually shipped). 142. What type of geographic pricing policy would a marketing manager most appropriately choose for the following products: (1) nationally advertised bubble gum, (2) rebuilt engines for jet airplanes, and (3) bulk amounts of a rare spice harvested from a single mountain in Canada and used in high-priced restaurants? Justify your answers, and specify any assumptions you used to arrive at your answer. ANSWER:Geographic pricing policies should be compatible with the total price structure of the firm, so assumptions about the company’s pricing objectives and other pricing policies will affect responses. Additionally, assumptions about competitors’ practices and customs in the industry are important. Bubblegum: In this case, identical retail prices would be sought, so the bubble gum should be delivered at the same price throughout the country. This would result in a pricing policy of uniform delivered pricing or possibly freight absorption pricing if competition is extremely intense. Engines: Because engines are large and heavy, transportation costs are an important component of pricing. In this case, FOB origin pricing could be used to put the burden of transportation on the purchasers. This pricing policy could be assumed if there were few competitors in the jet engine business. Otherwise, basing-point pricing would be the most appropriate pricing policy, though this type of pricing is being used less frequently due to adverse court rulings. Spice: Zone pricing would be appropriate in this case. Because the spices are sold in bulk, it should be assumed that transportation costs are not insignificant. Uniform delivered pricing is not appropriate because there is no heavy competition. FOB origin pricing could be used as well, because other pricing aspects of the spice might outweigh the transportation costs. 143. Marketing managers can use a wide variety of special pricing tactics to fine-tune prices. Name and define five of the special pricing tactics that are legal. For each tactic, give an example of a specific company, industry, or product that would use the tactic. 9 ANSWER:Single-pricetactic means all goods and services are offered at the same price (or perhaps two or three prices). Examples of retailers include One Price Clothing Stores, Dollarama, Your $10 Store, and Fashions $9.99. Flexiblepricingorvariablepricing means different customers pay different prices for essentially the same merchandise purchased in equal quantities. Car dealers, many appliance retailers, and manufacturers of industrial installations commonly used this method. Professionalservicespricing refers to the charging of an hourly rate or a fee based on some problem solution or performance. Lawyers, architects, and management consultants are all examples. Pricelining is the practice of offering a product line with several items at specific pricing points. This method is used by many boutiques. Leaderpricing is a method used to attract customers to a store by offering a product at or below cost with the hope the customer will buy other merchandise while in the store. Supermarkets are the most used example. Odd-evenpricingorpsychologicalpricing uses a price ending in an odd number to connote a bargain and a price ending in an even number to connote quality. Discount stores use odd pricing, and specialty boutiques use even pricing. Pricebundling is marketing two or more products in a single package for a special price. The tourist industry does this frequently as do fast-food restaurants with their deal for a drink, a sandwich, and an order of fries. Two-partpricing means establishing two separate charges to consume a single good or service. Examples include health and tennis clubs that charge both a membership fee and a fee each time the facilities are used. 144. Name five of the special pricing tactics. Give one advantage and one disadvantage associated with using each of the tactics you have named. ANSWER:Single-pricetactic: Advantages include (1) removal of price comparisons from the buyer’s decision-making process, (2) a simplified pricing system, and (3) minimization of clerical errors. Disadvantages include (1) continually rising costs and (2) necessity for frequent revisions of the selling price. Flexible(orvariable)pricing: Advantages include (1) possibility of adjustments for meeting or beating another seller’s price, (2) ability for the seller to close a sale with price-conscious consumers, and (3) ability to procure business from a potential high-volume shopper. Disadvantages include (1) the lack of consistent profit margins, (2) the potential ill will of highprice purchasers, (3) the tendency for salespeople to automatically lower the price in order to make a sale, and (4) the possibility of a price war among sellers. Professionalservicespricing: Advantages include (1) prices justified according to the education and experience of the service provider, and (2) the simplicity of flat-rate pricing. Disadvantages include (1) difÏculty in attaching dollar amounts to experience, education, or certifications, and (2) a temptation to charge “all that the trafÏc will bear” in an inelastic demand situation. Pricelining: Advantages include (1) reduction of confusion for salespeople and consumers, (2) a wider variety of merchandise offered to the buyer at each price, (3) the ability of the seller to reach several market segments, and (4) smaller total inventories for the seller. Disadvantages include (1) confusing changes in price line prices in times of rising costs and (2) 10 difÏculty in determining where to place the prices within a line. Leaderpricing: Advantages include (1) increase in store patronage, (2) potential higher volume of sales per customer, and (3) inducement of store switching. Disadvantages include (1) potential of consumers to stock up on only the leader items and (2) lack of response because of competition with other stores offering similar bargains. Baitpricing: Advantages may include (1) increase in store patronage, (2) potential higher volume of sales per customer, and (3) inducement of store switching. The main disadvantage is that the practice is illegal. Odd-even(orpsychological)pricing: Advantages include (1) implied bargains (odd) or quality (even) and (2) stimulation of demand for some products. Disadvantages include (1) creation of a saw-toothed demand curve and (2) changes in the price elasticity of demand. Pricebundling: Advantages include (1) stimulation of demand for the bundled items if the consumers perceive the price as a good value, (2) better coverage of constant fixed costs (especially in service industries), and (3) assistance in selling the maximum number of options (on a car, for example). Disadvantages include (1) customers’ resistance if one of the bundled items is not wanted and (2) consumers’ incorrect value perceptions. Priceunbundling: Advantages include keeping costs down. A possible disadvantage is that customers may not want to pay “extra” for items that have typically been bundled. Two-partpricing: Advantages include (1) consumers’ preference of two-part pricing when they are unsure of utilization, (2) high-use consumers paying a higher total price, and (3) possible increase in revenue for the seller by attracting low-use consumers. Disadvantages include (1) difÏculty in establishing pricing levels from usage estimates, and (2) resistance by high-use consumers. 145. Some pricing decisions are subject to government regulation. Name and define three pricing practices that are illegal. ANSWER: Pricefixing is an agreement between two or more firms on the price they will charge for a product or service. Several laws govern price fixing practices. Pricediscrimination occurs when a firm sells to two or more different buyers at different prices, and the result reduces competition. Price discrimination can also occur if the seller discriminates between buyers in terms of supplementary services provided, or if the buyers use their power to force sellers into discriminatory practices. Predatorypricing is the practice of charging a very low price with the intent of driving competitors out of business or out of the market. This practice is illegal. 146. What is a price fixing? ANSWER:Price fixing occurs when two or more companies conspire to set the prices for their products or services. It can be done by establishing a lowest price, in a bidding, situation or by simply setÝng the market price that the consumer will pay. 147. List and describe the six elements necessary for price discrimination to occur. 11 ANSWER: Two or three instances of discrimination must have occurred over time. The sales in question must have occurred within a relatively short period of time. The products sold must be commodities or tangible goods. The seller must charge different prices to two or more buyers for the same product. The products sold must be of the same quality and grade. The buyers of the good must be competitors. 148. How do value-based pricing, unbundling, and bundling help marketers hold onto market share during a recession? ANSWER:Value-based pricing stresses to customers that they are getÝng a good value for their money. Products that typically use prestige pricing can introduce products at a lower price, thereby earning lower profit margins, which are typically offset by increased sales volume. Unbundling allows a marketer to start charging separately for some products that were sold together prior to the economic recession. By selling items separately, the markets have a lower base price, which often appeals to consumers. Bundling can stimulate demand. When features are added to a product, consumers may perceive the offering as having greater value, which appeals to some consumers. 12