Page 431 - Marketing Management

408 PART 5 SHAPING THE MARKET OFFERINGS

Cutting prices to keep customers or beat competitors often encourages customers to demand
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price concessions, however, and trains salespeople to offer them. A price-cutting strategy can lead
to other possible traps:
• Low-quality trap. Consumers assume quality is low.
• Fragile-market-share trap. A low price buys market share but not market loyalty. The same
customers will shift to any lower-priced firm that comes along.
• Shallow-pockets trap. Higher-priced competitors match the lower prices but have longer
staying power because of deeper cash reserves.
• Price-war trap. Competitors respond by lowering their prices even more, triggering a price war. 82
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Customers often question the motivation behind price changes. They may assume the item is
about to be replaced by a new model; the item is faulty and is not selling well; the firm is in finan-
cial trouble; the price will come down even further; or the quality has been reduced. The firm must
monitor these attributions carefully.

Initiating Price Increases
A successful price increase can raise profits considerably. If the company’s profit margin is 3 percent of
sales, a 1 percent price increase will increase profits by 33 percent if sales volume is unaffected. This situ-
ation is illustrated in Table 14.6. The assumption is that a company charged $10 and sold 100 units
and had costs of $970, leaving a profit of $30, or 3 percent on sales. By raising its price by 10 cents (a
1 percent price increase), it boosted its profits by 33 percent, assuming the same sales volume.
A major circumstance provoking price increases is cost inflation. Rising costs unmatched by pro-
ductivity gains squeeze profit margins and lead companies to regular rounds of price increases.
Companies often raise their prices by more than the cost increase, in anticipation of further infla-
tion or government price controls, in a practice called anticipatory pricing.
Another factor leading to price increases is overdemand. When a company cannot supply all its
customers, it can raise its prices, ration supplies, or both. It can increase price in the following ways,
each of which has a different impact on buyers.
• Delayed quotation pricing. The company does not set a final price until the product is fin-
ished or delivered. This pricing is prevalent in industries with long production lead times, such
as industrial construction and heavy equipment.
• Escalator clauses. The company requires the customer to pay today’s price and all or part of
any inflation increase that takes place before delivery. An escalator clause bases price increases
on some specified price index. Escalator clauses are found in contracts for major industrial
projects, such as aircraft construction and bridge building.
• Unbundling. The company maintains its price but removes or prices separately one or more
elements that were part of the former offer, such as free delivery or installation. Car companies
sometimes add higher-end audio entertainment systems or GPS navigation systems as extras
to their vehicles.
• Reduction of discounts. The company instructs its sales force not to offer its normal cash and
quantity discounts.

TABLE 14.6 Profits Before and After a Price Increase
Before After

Price $10 $10.10 (a 1% price increase)
Units sold 100 100

Revenue $1,000 $1,010
Costs –970 –970
Profit $30 $40 (a 33 1/3% profit increase)