Pricing Strategies A Marketing Approach 1st Edition Schindler Solutions Manual Visit to download the full and correct content document: https://testbankdeal.com/dow nload/pricing-strategies-a-marketing-approach-1st-edition-schindler-solutions-manual/
Schindler, Pricing Strategies – Instructor Resources
Chapter 6: Answers to the End-of-Chapter Questions Exercises 1. A company had been selling 250 units per week of a product at a price of $20. When the company decreased the item’s price to $16, sales increased to 330 units per week. Calculate the price elasticity that represents the market’s response to this price change. Show your work. E = (% unit sales) / (% price) = {[(330 – 250)/250] x 100}/ {[16 – 20)/20] x 100} = 32% / –20% = –1.6
2. In an effort to increase profits, the Mid-Central Electric Co. is trying to decide whether to ask the Public Utilities Commission for permission to raise its rates. Some managers feel that a rate increase will not increase profits because higher rates will cause their customers to use less electricity, but other managers disagree. Finally, the numbers are in: The director of marketing has determined that the breakeven sales level for a rate increase of 5 percent would be a unit sales loss of 8.6 percent. The market research department has determined that the price elasticity of Mid-Central's market is –1.12. Use these numbers to determine whether or not it would increase Mid-Central’s profits to raise rates by 5 percent. Show your work. Calculate the sales change indicated by a price elasticity of –1.12: %S = E x %P = –1.12 x 5% = –5.6% This expected sales change is less than the breakeven sales change of –8.6%. Thus, it would increase Mid-Central’s profits to raise rates by 5%.
3. A study by economists has determined that the category price elasticity of the consumer car rental market in the United States is –1.25. National Car Rental is considering lowering its prices by 6 percent. (a) If Hertz, Avis, and the other nationwide car rental companies match National’s price cut, what is the sales change that National can expect? Show your work. If all competitors change in parallel, then the category price elasticity would predict the sales response: %Δ sales = E x %Δ in the average price = –1.25 x (–6%) = 7.5% If National lowers it price by 6%, it can expect its sales to increase by 7.5%
(b) If National’s competitors maintain their prices and do not match National’s price cut, how would that affect the sales-change estimate you gave for Part (a)? Explain your reasoning. If competitors do not match (or exceed) National’s price cut, some customers would switch to National. This could create sales increase for National greater than 7.5%. How much greater would depend on the brand elasticity. Applying the four economic factors that affect brand price elasticity: Does the price change involve what the customer would consider a large amount of money? Maybe Will the buyer actually incur the full extent of the price change? Maybe Are the customers’ switching costs low in the product category? Yes Are the customers’ search costs low in the product category? Yes Suggests that, at least for some market segments, there would be a considerable amount of brand price elasticity.
4. For each of the following products, answer each of the four questions relating to economic factors behind price-change response. Be prepared to explain your reasoning for each answer. Then use these answers to rank these products by their likely brand price elasticities. (a) A filling by your dentist All answers below are in order of (1) large amount of money, (2) pay full amount, (3) low switching costs, and (4) low search costs Filling by dentist: no, maybe, no, no Suggests lowest price elasticity among these four products (b) 2012 Honda Accord Yes, yes, yes, probably Suggests relatively high price elasticity among these four products (c) A fender repair by McKenzie’s Auto Body Yes, no, yes, no Suggests price elasticity in the middle among these four products (d) Box of Q-tip cotton swabs No, yes, yes, yes Suggests relatively high price elasticity among these four products
5. Tropicana is considering raising the price of its 59-ounce container of fresh orange juice by $0.50. Give and justify your view of the competitive stance that Minute Maid orange juice would be likely to take. What would be the implication of this stance for the price-change response that Tropicana could expect? If one estimates that Minute Maid and Tropicana are of comparable relative size, have comparable unit costs, and have relatively undifferentiated products, then it would suggest that Minute Maid would take a cooperative stance with respect to Tropicana.
If one argues that Minute Maid has goals to expand its market share, it would suggest an aggressive stance. If one argues that Minute Maid and Tropicana are highly differentiated brands, it would suggest a dismissive stance.
6. Apex Products is one of three large firms that together share a major proportion of sales in the U.S. market for metal replacement parts for a certain type of industrial machinery. Consideration of costs along with estimates of the category price elasticity for this type of replacement part indicates that a 12 percent price increase would increase Apex’s profits. (a) Describe how Apex’s two competitors would respond to Apex’s prospective price increase if they maintained a cooperative stance toward Apex? How would they respond if they held an aggressive stance toward Apex? How would they respond if they held a dismissive stance toward Apex? Cooperative stance: they will be likely to match Apex’s price increase. The attractiveness of Apex’s price relative to that of its competitors would not change. Aggressive stance: They will maintain their product’s price or increase it by a smaller amount. Apex’s price would be relatively less attractive to customers. Dismissive stance: They will maintain their product price; therefore they would decrease the attractiveness of Apex’s price. (b) Why should the competitive stance of the two competitors in this market affect Apex’s decision concerning whether or not to go ahead with this 12 percent price increase? If Apex’s competitors adopt a cooperative stance, then the category price elasticity would predict Apex’s price-change response. Since consideration of the category price elasticity indicated that the price increase would be profitable, a cooperative stance by Apex’s competitors should lead to a decision to increase the product’s price. If Apex’s competitors adopt an aggressive or dismissive stance, then Apex’s price-change response is likely to be greater than that predicted by the category price elasticity, and Apex should reconsider the desirability of this possible price increase. (c) What information should Apex take into account to determine the likely response of each competitor? How might it obtain this information? Apex’s manager should examine the two competitors’ responses to past price changes of Apex or other competitors. Also, they should consider the relative size of the companies, the degree of brand differentiation, possible differences in unit costs, and company goals. Sources of competitors’ information: - Marketplace (salespeople, shopping the competition) - Trade associations and trade publications - Reports of securities analysts (d) If Apex plans to proceed with the price increase, what information should it communicate to competitors? How might Apex communicate this information?
If Apex wants to communicate information that could serve as a signal to encourage matching the intended price increase, it could mention: An order backlog indicating the need to raise prices An increase in the costs of components They should communicate this information in a public way, e.g., in a press release, news conference, or during a speech or media interview. Review and Discussion Questions 1. What is meant when it is said that a market is “sensitive” to a price change? What is meant when it is said that a market is “insensitive” to a price change? If there is a large price-change response, the market is “sensitive”. If there is little price-change response, the market is “insensitive”. 2. Give the formula for price elasticity. Explain why the quantities in this formula are percents rather than specific units, such as dollars, euros, or yen. E = %∆ Unit sales / %∆P Rather than using the size of the sales change, the sales-change percent can be used; rather than using the size of the price change, the price-change percent can be used. This creates a measure that is independent of how sales and price changes are measured and thus can be compared over various situations. 3. Explain why price elasticities are usually negative numbers. Would a price elasticity calculated from a price decrease be more likely to be a negative number than a price elasticity calculated from a price increase? Explain. Whether price elasticity is calculated from a price increase or from a price decrease, the elasticity will usually be a negative number. This is because it is generally the case that when a product’s price is increased, there is a decrease in the number of units of the product that are sold. When a product’s price is decreased, it generally leads to an increase in unit sales. 4. What is a demand curve? What is it about the shape of a demand curve developed from real data that indicates the importance of the situation in which a price elasticity is measured? A demand curve shows the relationship between various prices a product can have and the sales that would occur at that price. As can be seen from any demand curve that has been developed from real data, the market’s sales response to an item’s price is not a smoothly varying function of that price. This means that a product’s price elasticity measured at, say, low price levels might differ from the price elasticity measured at high price levels. 5. If the breakeven sales level for a 10 percent price decrease is an increase of 14 units over a base sales level of 100 units, would a price elasticity of –1.5 indicate that this price decrease would be profitable? Explain your reasoning. %Δ Unit sales = E x %ΔP = –1.5 x (–10%) = 15%
The calculation tells us that in this situation, a 10% price decrease will result in a 15% sales increase. A 15% sales increase from the base sales level of 100 units is an increase of 15 units per week (0.15 x 100 units). This exceeds the calculated breakeven sales level of 14 units per week. Thus, a price elasticity of –1.5 indicates that the 10% decrease in price being considered would result in higher gross profits for this product. 6. If the breakeven price elasticity for a prospective price increase were –1.2, would an actual price elasticity of –1.3 indicate that the price increase would be profitable? Explain your reasoning. A breakeven price elasticity for a price increase indicates the maximum amount of price sensitivity that would allow a price increase to be profitable or break even. Since a price elasticity of –1.3 indicates more price sensitivity than this maximum, it indicates that the price increase being considered would not be profitable. 7. What is the difference between a category price elasticity and a brand price elasticity? The category price elasticity (primary demand elasticity) is the percent change in sales for an entire product category divided by the percent change in the average price for an item in that product category. The market’s response to a price change in a brand is known as the brand price elasticity (selective or inter-brand demand elasticity). The brand price elasticity is the percent change in the sales of a particular brand divided by the percent change in that brand’s price. 8. Describe a price-change situation where the brand price elasticity is likely to be similar to the category price elasticity. If the competitive response to a company’s price change is such that all of the company’s competitors in the industry match the change, then the brand price elasticity and the category price elasticity become equal. For example, if Uniroyal increased its prices by 10 percent, and Goodyear, Dunlop, Kelly-Springfield, and all of the other tire manufacturers followed suit, then there would be no reason for customers to switch from Uniroyal to another brand. In that case, the market response to Uniroyal’s price change would be represented by the category price elasticity for automobile tires. 9. Describe the distribution of brand price elasticities typically observed. Why is it useful for a pricing manager to be aware of this distribution? In a paper published in the Journal of Marketing Research, researchers reported the results of compiling the brand price elasticities found in dozens of marketplace studies published between the years 1961 and 2004. The distribution of the 1,851 brand price elasticities they collected can be seen in Figure 6.3. Although brand price elasticities can vary widely, they typically were found to be around the median elasticity value of –2.22. Over 80 percent of the observed price elasticities fell between 0 and –4. This study found elasticities with a positive sign occurred only about two percent of the time. Knowing that the likely range of brand price elasticities is between 0 and –4 is in itself of some value to a pricing manager. Say the breakeven analysis of a prospective price decrease indicates that the brand’s price elasticity would have to be greater than –4 for the price change to be
profitable. Simply knowing that such a level of price elasticity is unlikely to be observed – without any further information – alerts the price setter to the doubtful wisdom of the price change. 10. What is the effect of the amount of money involved in a price change on the market’s likely response to the price change? How might this effect be related to the frequency with which consumers purchase the product and the ease of storing the product? Customers can be expected to show a greater response to a price change the greater the amount of money that is involved in the price change. Thus, a one-thousand dollar price increase for a new car is likely to affect customers more than a twenty-cent price increase for a jar of mustard. Also, it is likely that a twenty-cent price increase for a gallon of milk or a dozen eggs will affect consumers more than that same price increase for a jar of mustard. This is because milk and eggs are usually purchased far more frequently than mustard, and thus a change in their prices involves a greater amount of money. If a twenty-cent price decrease, rather than increase, is considered, it is likely that the decrease will affect sales of facial tissues or paper towels more than milk or eggs even though all four products are frequently purchased. This is because facial tissues and paper towels can be stored and consumers can stock up in response to a price decrease and save a greater amount of money. Note that the extent of the reaction to the money involved in a price change is likely to be relative to the customer’s wealth. All of the price-change amounts mentioned above are likely to have a greater effect on customers who have small incomes than on those who are well-off. 11. Describe a situation in which the product’s customer does not pay the product’s full price. What are the implications of this for estimating the likely market response to a price change for this product? A product may be tax deductible, covered by insurance, or a customer’s employer may reimburse the employee for all or part of the product’s price. When the buyer does not pay the full amount of the product’s price, the buyer’s response to a price change can be expected to be less than if the buyer pays the full price. An extreme example of this is when an individual has the authority to make the product purchase decision for other individuals. This occurs for products such as college textbooks and prescription drugs. The professor and physician make the purchase decisions and the students and patients pay the price. The resulting low price sensitivity has been at least partially responsible for the many years of steady increases in the prices of these products 12. Describe a product category where it is relatively easy to gather information on alternative brands and to switch purchasing from one brand to another. What is the effect of this easy information gathering and switching on the market’s likely response to a price change? Chocolate chip cookies would be a product category where it is easy to gather information on alternative brands. If a consumer is unhappy with one brand, it is easy to pick up packages of some competing brands, try them, and then switch to a brand that the consumer finds more appealing. Such easy information gathering and switching tend to increase the size of the market’s response to a brand’s price change.
13. Why is it important to know whether or not a price change will change the price differentials between competitors? One of the key tasks in predicting the market response to a price change is to be able to anticipate how competitors will respond to the price change. The responses of these competitors are important because they determine how the price change will affect the price differentials between the initiator of the price change and its competitors. The price differential between two competitors is the difference in their prices for a particular product. A price change that changes the price differentials between competitors will probably cause a greater market response than one that does not. 14. What is a competitive stance? Why is it useful to know the competitive stance of one’s competitors? To a large extent, the competitive reaction to a price change is determined by each competitor’s general competitive stance toward the organization that considers initiating the price change. A competitive stance is a company’s posture, or set of response tendencies similar to an attitude. It can and does change, but companies are often found to hold the same stance for long periods of time. 15. Describe the three basic competitive stances. Indicate the response to a price increase that each would predict. Then indicate the response to a price decrease that each would predict. There are three basic competitive stances. The competitor who holds a cooperative stance does not want to rock the boat. This competitor is satisfied with the current situation with respect to the price-change initiator and prefers that things remain the same. The competitor who maintains an aggressive stance wants to improve his position at the expense of the price-change initiator. This competitor would like to see things change with respect to the initiator, in the direction of the competitor’s benefit. The competitor who holds a dismissive stance feels that whatever the initiator does will not substantially affect him. This competitor simply ignores the price-change initiator and makes no special response to the initiator’s price-change decisions. 16. How can information about a competitor’s past behaviors, or that of its executives, help provide an indication of the company’s competitive stance? The information that most accurately reveals a company’s competitive stance with respect to a price-change initiator is the company’s past behaviors. The price-change initiator should note how the competitor has responded to its price changes in the past. If the competitor has usually matched its increases and decreases, it suggests a cooperative stance. If the competitor has usually not followed the initiator’s price increases or responded to the initiator’s decreases with even larger decreases, it suggests an aggressive stance. If the competitor has failed to respond to the initiator’s past price decreases as well as its increases, it suggests a dismissive stance. If a company’s current executives had previously led other companies, then the price response of those other companies could help provide an indication of how these executives would lead in their current positions. 17. Explain why a company being of comparable size to competitors would favor its holding a cooperative stance.
Competitors of approximately equal size are likely to feel comparably powerful, which would tend to discourage the perception that an advantage could be gained by changing the price differential between them. For example, United, American, and Delta Airlines, along with Northwest and Continental tend to respond cooperatively to price increases or decreases by the others. The resulting tendency for their prices to rise and fall together is an example of what is known as parallel pricing. 18. Explain why a company with a highly differentiated brand would be likely to hold a dismissive stance. A company with a highly differentiated brand, such as Sony televisions, Apple’s iPhone, or Hugo Boss clothing, is less likely to be affected by the price changes of competitors. Thus, such companies would be more likely to adopt a dismissive stance toward the price changes of their competitors. 19. Explain why a company with lower unit costs than its competitors would be likely to hold an aggressive stance. An aggressive stance will tend to encourage price competition. Among competitors with equal perunit costs, there is unlikely to be a clear victor in price competition, and all of the competitors participating in price competition are likely to see lower profits. On the other hand, having lower per-unit costs puts a competitor in a better position to win in price competition, and thus reduces that competitor’s fear of it. 20. What are some of the possible sources of information about a company that could be used for determining the company’s competitive stance? The most accessible of these information sources is the marketplace itself. It is important to shop the competition – be aware of each competitor’s prices. In the same vein, be aware of the messages communicated in each competitor’s advertising, and the products and themes each competitor displays at trade shows. Other sources of competitive information include trade associations and trade publications. They will often provide accurate data on such key competitive dimensions as relative prices, market share, advertising expenditures, and even costs of commonly purchased components and supplies. The reports of securities analysts in brokerages and investment organizations can also be a valuable source of competitive data. Finally, it is important to keep in mind that your customers can be an important source of information about your competitors. A good salesperson will usually be able to draw from discussions with customers a considerable amount of information about the products, prices, and promotional messages of the other companies that call on those customers. 21. What is price signaling? Discuss the legality and effectiveness of price signaling strategies. When this publicly available price-related information is intentionally managed to have an effect on competitors, it is known as price signaling. Price signaling typically uses the techniques of publicity, as opposed to paid advertising, to communicate pricing information. For example, the company can signal competitors through news releases, press conferences, giving the media access to company executives, planting articles in op-ed pages of major newspapers, and through blogs and other materials posted on the Internet.
Price signaling is in a legal gray area. Determinations of its legality have hinged on factors such as the circumstances of the signaling (e.g., Is it seen in a market with only few large competitors?) and its consequences (e.g., Has the profitability of the products in question substantially increased?). There is not general agreement on the effectiveness of price signaling. There is some evidence from laboratory research that price signals are “likely to fall on deaf ears” unless the competitors are already of one mind concerning goals and strategies. This raises the possibility that pricing signaling could even backfire by raising the awareness of price competition and bringing to competitors’ minds the possibility of an aggressive response. 22. Describe some signals intended to discourage a competitor from initiating a price decrease. Explain how these signals could accomplish this effect. A company might publicize its intention to match or beat any price cuts initiated by competitors. This might give pause to an aggressive competitor, because such matching would prevent the favorable increase in the price differential that may have been intended by the competitor. Moreover, such a signal raises the possibility that initiating a price cut might lead to price warfare – companies successively exceeding each other’s price cuts – which can drastically reduce profits for all of the warring competitors. Such willingness-to-match signals could be supplemented with evidence of the company’s ability to carry out such matching price decreases. 23. Give some examples of how a price decrease could have limited goals. Discuss how signaling this could exert competitive influence. For example, the company could communicate that it is using the price cut only to maintain its market share, which otherwise would be slipping. Or, it could signal that the goal of the cut would be to take advantage of high category price elasticity – in other words, to expand the market. Ellisco, Inc., a small supplier of inner-threaded metal caps to consumer packaged goods manufacturers, publicly announced that its price cuts were to compete only for their customers’ “second-source” business – the small amount of business that manufacturers allot to small suppliers, as insurance against a disruption of their primary suppliers. In each of these limitedgoals signals, the intended message to the company’s competitors is, “there’s no need to match this price cut.” 24. Discuss the price signal that might be intended by a company executive giving an interview to a reporter and describing how the costs of his product’s components have gone up steadily over the past few months. Such a comment during a media interview could be intended to suggest that competitors interpret any cost increases they may have in a similar way. This interpretation could give competitors a justification for also increasing prices, and thus could be considered a signal for matching a planned price increase. 25. Describe a four-cell payoff matrix. Discuss how it could be useful for pricing decisions even though it considers only two competitors and two price levels. Game theory involves examining possible patterns of behaviors in order to help predict and manage price competition. A useful tool of game theory is a four-cell diagram known as a payoff
matrix. The payoff matrix can be useful for pricing decisions because it captures part of the essence of price competition: a company considering a price change and thinking about how a competitor is likely to react. The simplicity of the payoff matrix helps a company see how the competitive game might unfold as it is played repeatedly over time. This can help pricing managers see the longer-term consequences of possible price changes.