Return on Investment
Marketers should understand the position of their company and the returns expected when making adjustments in prices.
Explain why pricing objectives focus on delivering a return on investment (ROI)
- Return on investment is one way of considering profits in relation to capital invested.
- Marketing not only influences net profits but also can affect investment levels, too. New plants and equipment, inventories, and accounts receivable are three of the main categories of investments that can be affected by marketing decisions.
- ROI provides a snapshot of profitability adjusted for the size of the investment assets tied up in the enterprise.
- accounts receivable: Accounts receivable refers to the money owed to a business by its clients (customers) and shown on its balance sheet as an asset.
- receivables: All the debts owed to a company by its debtors or customers.
Pricing objectives or goals give direction to the whole pricing process. Determining what your objectives are is the first step in pricing. When deciding on pricing objectives, you must consider:
1. The overall financial, marketing, and strategic objectives of the company
2. The objectives of your product or brand
3. Consumer price elasticity and price points
4. The resources you have available
One of the most common pricing objectives is obtaining a target rate of return on investment (ROI). Return on investment is one way of considering profits in relation to the capital invested. Marketing not only influences net profits but also can affect investment levels, too. New plants and equipment, inventories, and accounts receivable are three of the main categories of investments that can be affected by marketing decisions. Hence, it is important to keep all investments in mind when setting prices. It doesn’t pay to be narrow in focus.
The purpose of the return on investment metric is to measure per period rates of return on dollars invested in an economic entity. For example, this chart shows the rate of return on investments after training teachers. It provides a snapshot of profitability adjusted for the size of the investment assets tied up in the enterprise. Marketing decisions, such as setting prices, have obvious potential connection to the return on investment, but these same decisions often influence asset usage and capital requirements (for example, receivables and inventories). Marketers should understand the position of their company and the returns expected. Return on investment is often compared to expected (or required) rates of return on dollars invested.
Increasing market share is one of the most important objectives of business and pricing may offer a mechanism to increase share.
Explain the relationship between market share and pricing strategies
- Marketers need to be able to translate sales targets into market share because this will determine whether forecasts are to be attained by growing with the market or by capturing share from competitors.
- Market share is a key indicator of market competitiveness—that is, how well a firm is doing compared to its competitors. It enables them to judge not only total market growth or decline but also trends in customers’ selections among competitors.
- Losses in market share can signal serious long-term problems that require strategic adjustments. Firms with market shares below a certain level may not be viable.
- Market Share: The percentage of a market (defined in terms of either units or revenue) accounted for by a specific entity.
Market share is a key indicator of market competitiveness—that is, how well a firm is doing compared to its competitors. It enables them to judge not only total market growth or decline but also trends in customers’ selections among competitors. Generally, sales growth resulting from primary demand (total market growth) is less costly and more profitable than that achieved by capturing share from competitors. Conversely, losses in market share can signal serious long-term problems that require strategic adjustments. Firms with market shares below a certain level may not be viable. Similarly, within a firm’s product line, market share trends for individual products are considered early indicators of future opportunities or problems.
Just as survival requires a long-term profit for a business enterprise, profit requires sales. The task of marketing management relates to managing demand. Demand must be managed in order to regulate exchanges or sales. Thus marketing management’s aim is to alter sales patterns in some desirable way. They are concerned with maintaining an adequate share of the market so that their sales volume will enable the firm to survive and prosper. Again, pricing strategy is one of the tools that is significant in creating and sustaining market share. Prices must be set to attract the appropriate market segment in significant numbers. Decreasing price may increase demand and lead to higher market share, though it could also provoke a competitive response.
Marketers need to be able to translate sales targets into market share because this will determine whether forecasts should be attained by growing with the market or by capturing share from competitors. The latter will almost always be more difficult to achieve. Market share is closely monitored for signs of change in the competitive landscape, and it frequently drives strategic or tactical decisions. Increasing market share is one of the most important objectives of business. The main advantage of using market share as a measure of business performance is that it is less dependent upon macro environmental variables such as the state of the economy or changes in tax policy.
Cash flow is extremely important to firms as this is how they buy goods, pay employees, fund new investments, and pay dividends.
Identify the different pricing strategies for generating cash flow in an organization
- Some companies will set prices so that they can recover cash flow as quickly as possible. This strategy could be due to the company spending too much of its resources on developing products.
- One way to get cash flow quickly is through seasonal discounts. Seasonal discounts are price reductions given on out-of-season merchandise.
- Another option is cash discounts. Cash discounts are reductions on the base price given to customers for paying cash or within some short time period.
- seasonal discount: price reductions given when an order is placed in a slack period
- cash flow: The movement of money into or out of a business.
Cash flow is the movement of money into or out of a business. The measurement of cash flow can be used for calculating other parameters that give information on a company’s value and situation. Some companies will set prices so that they can recover cash flow as quickly as possible. This strategy could be due to the company spending too much of its resources on developing products. This typically requires setting prices very high, which is a disadvantage since competitors can set prices lower and gain a larger market share.
Cash flow is extremely important to a firm. This is how they buy goods, pay employees, fund new investments, and pay dividends. It is necessary to determine the effects of pricing on cash flow to a firm.
One way to get cash flow quickly is through seasonal discounts. Seasonal discounts are price reductions given for out-of-season merchandise. An example would be a discount on snowmobiles during the summer. The intention of such discounts is to spread demand over the year. This can allow for the fuller use of production facilities and improved cash flow throughout the year.
Another option is cash discounts. Cash discounts are reductions on the base price given to customers for paying cash or within some short time period. For example, a company can give a two percent discount on bills paid within 10 days. Another example is a gas station that gives discounts on gas prices to costumers who don’t pay with credit cards. The purpose is generally to accelerate the cash flow of the organization.
Status quo pricing is the concept that some goods within certain industries have an expected price for consumers, due to a relative norm within that market.
Recognize that some product types have relative consistent pricing, and entering those markets often requires the ability to produce at that price or lower
- Many products and services have relatively normal expected prices, usually due to a balance of demand, competition, and economic factors.
- In order to effectively compete in those markets, organizations must refine their process to produce at the status quo price point or lower in order to satisfy the needs of consumers in that market.
- Status quo price points usually evolve organically as a byproduct of external and competitive forces.
- It is important to differentiate price fixing and status quo pricing. Price fixing is an agreement among competitive firms to set prices at the same level in order to attain a monopoly. This is illegal under antitrust laws in most countries.
- status quo: The state of things; the way things are, as opposed to the way they could be; the existing state of affairs.
- price fixing: An agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.
When setting a price for a given product or service, there are countless objectives an organization may have that will impact how and why a price is determined. While there are too many objectives to provide a comprehensive list, some of the more common pricing objectives include:
- Maximizing short-term or long-term profit
- Increasing sales volume
- Increasing market share and/or growth
- Becoming a price leader
- Differentiating for a niche segment
- Social, ethical, or ideological objectives (e.g. making something available to consumers with lower incomes)
- Attaining the competitive equilibrium
Many industries have key competitors that wield a great deal of power and influence within the industry. As a result, new entrants and smaller players are often forced to attain a similar efficiency in operations and become able to sell a given good at a specific price or lower. These larger, strong players often have scale economies, which slowly make the ‘status quo’ price of a given good lower than is obtainable by other incumbents.
Status Quo Pricing
As a result of this, some firms pursue status quo pricing as a pricing objective. In this situation, they assess the overall market to determine what the going prices are for the product or service they will sell. Once this price point is established, the organization will strive to build an operational mechanism that enables the organization to be profitable at the price point (or possibly lower). This objective is particularly useful when applied to mature industries with firmly set price points and a low variance in price elasticity in the consumer groups.
These status quo price points arise organically, based on consumer behavior, competitive factors, and the price of production. Status quo prices are often associated with homogeneous goods for which the price has been lowered significantly through competition.
An extremely important ethical consideration of this pricing objective is avoidance of price fixing. Price fixing is the illegal practice of various competitive firms within an industry agreeing on a fixed price for goods within an industry. If all competitive firms agree on price, there is no real practical different for the consumer between this and a monopoly.
The purpose of price fixing is identifying the highest possible optimal price point that can be charged for a given good within a market, which will in turn benefit all of the providers of that good. This is a criminal offense in the United States and can be prosecuted under the Sherman Antitrust Act.