Marketing Management

MBA - Course Notes

Islam Mohamed Fahmy

28/02/2010

Contents
Chapter 12: Setting Product Strategy.................................................................................................... 3
Chapter Questions........................................................................................................................... 3
What is a Product?........................................................................................................................... 3
Five Product Levels......................................................................................................................... 3
Product Classification Schemes......................................................................................................... 4
Product Differentiation.................................................................................................................... 5
Service Differentiation..................................................................................................................... 6
The Product Hierarchy..................................................................................................................... 7
Product Systems and Mixes............................................................................................................... 8
Chapter 14: Developing Pricing Strategies and Programs.........................................................................9
Chapter Questions........................................................................................................................... 9
What is a Price?.............................................................................................................................. 9
Common Pricing Mistakes................................................................................................................. 9
Consumer Psychology and Pricing...................................................................................................... 9
Steps in Setting Price..................................................................................................................... 11
Step 1: Selecting the Pricing Objective......................................................................................... 11
Step 2: Determining Demand....................................................................................................... 12
Step 3: Estimating Costs............................................................................................................. 13
Step 4: Analyzing Competitors' Costs, Prices, and Offers.................................................................14
Step 5: Selecting a Pricing Method............................................................................................... 14

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Chapter 12:

Setting Product Strategy

Chapter Questions

What are the characteristics of products and how do marketers classify products?
How can companies differentiate products?
How can a company build and manage its product mix and product lines?
How can companies combine products to create strong co-brands or ingredient brands?
How can companies use packaging, labeling, warranties, and guarantees as marketing tools?

What is a Product?

A product is anything that can be offered to a market to satisfy a want or need, including physical goods,
services, experiences, events, persons, places, properties, organizations, information, and ideas.
Components of the Market Offering:
o Value based prices
o Product features and quality
o Services mix and quality

Five Product Levels

Products are the means to an end wherein the end is the satisfaction of customer needs or wants. Kotler
distinguished three components:
o Need: a lack of a basic requirement;
o Want: a specific requirement for products or services to match a need;
o Demand: a set of wants plus the desire and ability to pay for the exchange.

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Customers will choose a product based on their perceived value of it. Satisfaction is the degree to which the
actual use of a product matches the perceived value at the time of the purchase. A customer is satisfied only if
the actual value is the same or exceeds the perceived value. Kotler defined five levels to a product:
1. Core Benefit: the fundamental need that consumers satisfy by consuming the product or service.
(example: for Hotel; rest & sleep are core benefits)
2. Basic Product: a version of the product containing only those attributes or characteristics absolutely
necessary for it to function. (example: for Hotel; bed, bathroom, etc..)
3. Expected Product: the set of attributes or characteristics that buyers normally expect and agree to when
they purchase a product. (example: for Hotel; clean bed, clean bathroom, calm, etc..)
4. Augmented Product: inclusion of additional features, benefits, attributes or related services that serve to

differentiate the product from its competitors. Competition takes place at the Augmented Product level.
5. Potential Product: all the augmentations and transformations a product might undergo in the future.
Kotler noted that much competition takes place at the Augmented Product level rather than at the Core
Benefit level or, as Levitt put it: 'New competition is not between what companies produce in their factories,
but between what they add to their factory output in the form of packaging, services, advertising, customer

advice, financing, delivery arrangements, warehousing, and other things that people value.'
Kotler's model provides a tool to assess how the organization and their customers view their relationship and
which aspects create value.

Product Classification Schemes

Durability and Tangibility
Nondurable Goods:
consumed relatively fast in
one or few uses (FMCG:
Fast Moving Consumer
Goods).
Durable Goods: get used
repetitively over a long
period of time.
Services: Intangible
products; usually it doesnt
result in ownership of any
tangible thing.

Consumer Goods

Industrial Goods

Convenience Goods: purchased on regular

basis without a lot of comparison to
alternatives; e.g. newspapers.
Shopping Goods: consumer compares
alternatives based on order qualifiers &
order winners; e.g. furniture, appliances,
clothes.
Specialty Goods: where consumer goes for
unique characteristics and/or brand
identification; specific brands for fancy
products.
Unsought Goods: consumer doesnt know
about it or consumer may know about it
but doesnt think of buying it.

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Materials and Parts: are used and/or

transformed into the final product; e.g.
raw material.
Capital Items: are used to execute
transformation processes; e.g. buildings,
machines, tools, etc
Supplies: goods used to operate & support
transformation process, but dont be a part
of the finished product.
Business Services: get consumed
internally; e.g. consultancy, cleaning, etc

Product Differentiation

Form: size, shape, or physical structure of a product. Consider the many possible forms taken by products such
as aspirin. Although aspirin is essentially a commodity, it can be differentiated by dosage size, shape, color,

coating, or action time.

Features: Most products can be offered with varying features that supplement its basic function.
Customization: differentiate products by making them customized to an individual.
o Mass Customization is the ability of a company to meet each customer's requirements-to prepare on a

mass basis individually designed products, services, programs and communications.

Performance Quality: Most products are established at one of four performance levels: low, average, high, or

superior. Performance Quality is the level at which the product's primary characteristics operate.
Conformance Quality: Buyers expect products to have a high conformance quality, which is the degree to

which all the produced units are identical and meet the promised specifications.
Durability: Durability is a measure of the product's expected operating life under natural or stressful

conditions, is a valued attribute for certain products.

Reliability: Buyers normally will pay a premium for more reliable products. Reliability is a measure of the

probability that a product will not malfunction or fail within a specified time period.
Repairability: Repairability is a measure of the ease of fixing a product when it malfunctions or fails. Ideal

repairability would exist if users could fix the product themselves with little cost in money or time.
Style: Style describes the product's look and feel to the buyer. Style has the advantage of creating
distinctiveness that is difficult to copy. On the negative side, strong style does not always mean high

performance.
Design (The Integrative Force): Design is the totality of features that affect how a product looks and
functions in terms of customer requirements. As competition intensifies, design offers a potent way to
differentiate and position a company's products and services.

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Service Differentiation
When the physical product cannot easily be differentiated, the key to competitive success may lie in adding valued
services and improving their quality. The main service differentiators are: ordering ease, delivery, installation,
customer training, customer consulting, and maintenance and repair.

Ordering Ease: refers to how easy it is for the customer to place an order with the company.
Delivery: refers to how well the product or service is delivered to the customer. It includes speed, accuracy,

and care attending the delivery process.

Installation: refers to the work done to make a product operational in its planned location. Buyers of heavy

equipment expect good installation service.

Customer Training: refers to training the customer's employees to use the vendor's equipment properly and

efficiently.
Customer Consulting: refers to data, information systems, and advice services that the seller offers to buyers.
Maintenance and Repair: describes the service program for helping customers keep purchased products in

good working order.

Returns: Although product returns are undoubtedly a nuisance to customers, manufacturers, retailers, and
distributors alike, they are also an unavoidable reality of doing business, especially with online purchases. We
can think of product returns in two ways:
o Controllable Returns result from problems, difficulties, or errors of the seller or customer and can
mostly be eliminated with proper strategies and programs by the company or its supply chain partners.
Improved handling or storage, better packaging, and improved transportation and forward logistics can
o

eliminate problems before they happen.

Uncontrollable Returns can't be eliminated by the company in the short-run through any of these
means.

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The Product Hierarchy

Product and Brand Relationships: Each product can be related to other products to ensure that a firm is

offering and marketing the optimal set of products.

The Product Hierarchy stretches from basic needs to particular items that satisfy those needs. We can identify
six levels of the product hierarchy (using life insurance as an example):
1. Need Family -The core need that underlies the existence of a product family.
o Example: security.
2. Product Family - All the product classes that can satisfy a core need with reasonable effectiveness.
o Example: savings and income.
3. Product Class -A group of products within the product family recognized as having a certain functional
coherence. Also known as product category.
o Example: financial instruments.
4. Product Line -A group of products within a product class that are closely related because one or more of
the following reasons:
They perform a similar function
Or they are sold to the same customer groups
Or they are marketed through the same outlets or channels
Or they fall within given price ranges.
o A product line may be composed of different brands or a single family brand or individual brand
that has been line extended.
o Example: life insurance.
5. Product Type - A group of items within a product line that share one of several possible forms of the
product.
o Example: term life insurance.
6. Item (also called stock-keeping unit or product-variant) - A distinct unit within a brand or product line
distinguishable by size, price, appearance, or some other attribute.
o Example: Prudential renewable term life insurance.

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Product Systems and Mixes

Product System: is a group of diverse but related items that function in a compatible manner.
o Example: PalmOne handheld and smartphone product lines come with attachable products including
headsets, cameras, keyboards, presentation projectors, e-books, MP3 players, and voice recorders.
Product Mix: (also called a product-assortment) is the set of all products and items a particular seller offers
for sale. A product mix consists of various product lines.
o Example: NEC's (Japan) product mix consists of communication products and computer products.
o

Michelin has three product lines: tires, maps, and restaurant-rating services.
Example: At Northwestern University, there are separate academic deans for the medical school, law
school, business school, engineering school, music school, speech school, journalism school, and liberal

arts school.
A company's product mix has a certain width, length, depth, and consistency.
Width of a Product Mix: refers to how many different product lines the company carries.
Length of a Product Mix: refers to the total number of items in the mix.
o Average Length of a Product Mix: is obtained by dividing the total Length by Width.
Depth of a Product Mix: refers to how many variants are offered of each product in the line.
o Average Depth of a Product Mix: is obtained by averaging the number of variants within the brand
o

groups.
Example: If Tide comes in two scents (Mountain Spring and Regular), two formulations (liquid and
powder), and two additives (with or without bleach), Tide has a depth of eight because there are eight

distinct variants.
Consistency of a Product Mix: refers to how closely are related the various product lines in one or more of the
following characteristics:
End use
Or production requirements
Or distribution channels
Or some other way.
o Example: P&G's product lines are consistent insofar as they are consumer goods that go through the
same distribution channels. The lines are less consistent insofar as they perform different functions for

the buyers.
These four product-mix dimensions permit the company to expand its business in four ways. It can add new
product lines, thus widening its product mix. It can lengthen each product line. It can add more product
variants to each product and deepen its product mix. Finally, a company can pursue more product-line
consistency. To make these product/brand decisions, its useful to conduct Product-Line Analysis.

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Chapter 14:

Developing Pricing Strategies and Programs

Chapter Questions

How do consumers process and evaluate prices?

How should a company set prices initially for products or services?
How should a company adapt prices to meet varying circumstances and opportunities?
When should a company initiate a price change?
How should a company respond to a competitors price challenge?

What is a Price?

Price: is amount of money charged for a product (good or service). Price is the only Marketing Mix element
that produces revenue. Price is the easiest element that can be adjusted.

Common Pricing Mistakes

Determine costs and take traditional industry margins

Failure to revise price to capitalize on market changes
Setting price independently of the rest of the marketing mix
Failure to vary price by product item, market segment, distribution channels, and purchase occasion

Consumer Psychology and Pricing

Reference Prices: when examining products, consumers often compare it to an internal reference price
(pricing information from memory) or an external frame of reference (such as a posted "regular retail price").
All types of reference prices are possible:
"Fair Price" (what the product should cost)
Typical Price
Last Price Paid
Upper-Bound Price (reservation price or what most consumers would pay)
Lower-Bound Price (lower threshold price or the least consumers would pay)
Competitor Prices
Expected Future Price
Usual Discounted Price
o Sellers often attempt to manipulate reference prices. For example, a seller can situate its product
among expensive products to imply that it belongs in the same class. Department stores will display
women's apparel in separate departments differentiated by price; dresses found in the more expensive
department are assumed to be of better quality. Reference-price thinking is also encouraged by stating
a high manufacturer's suggested price, or by indicating that the product was priced much higher
o

originally, or by pointing to a competitor's high price.

Clever marketers try to frame the price to signal the best value possible. For example, a relatively
more expensive item can be seen as less expensive by breaking the price down into smaller units. A
$500 annual membership may be seen as more expensive than "under $50 a month" even if the totals
are the same. When consumers evoke one or more of these frames of reference, their perceived price
can vary from the stated price. Research on reference prices has found that "unpleasant surprises"
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when perceived price is lower than the stated pricecan have a greater impact on purchase likelihood

than pleasant surprises.

Price-Quality Inferences: Many consumers use price as an indicator of quality. Image pricing is especially
effective with ego-sensitive products such as perfumes and expensive cars. When alternative information about
true quality is available, price becomes a less significant indicator of quality. When this information is not
available, price acts as a signal of quality.
o Example: A $100 bottle of perfume might contain $10 worth of scent, but gift givers pay $100 to
communicate their high regard for the receiver. Price and quality perceptions of cars interact. Higherpriced cars are perceived to possess high quality. Higher-quality cars are likewise perceived to be

higher priced than they actually are.

Price Endings: Many sellers believe prices should end in an odd number. Research has shown that consumers
tend to process prices in a "left-to-right" manner rather than by rounding. Price encoding in this fashion is
important if there is a mental price break at the higher rounded price. Another explanation for the popularity
of "9" endings is that they convey the notion of a discount or bargain, suggesting that if a company wants a
high-price image, it should avoid the odd-ending tactic. One study even showed that demand was actually
increased one-third when the price of a dress rose from $34 to $39 but was unchanged when the price

increased from $34 to $44.25

Price Cues: such as sale signs and prices that end in 9 become less effective the more they are employed. They
are more influential when consumers' price knowledge is poor, when they purchase the item infrequently or are
new to the category, and when product designs vary over time, prices vary seasonally, or quality or sizes vary
across stores. Limited availability (for example, "three days only") also can spur sales among consumers actively
shopping for a product.
o Price Cues are:
Left to right pricing ($299 vs. $300): Customers see an item priced at $299 in the $200 rather
than the $300 range.
Odd number discount perceptions
Even number value perceptions
Ending prices with 0 or 5: common in the marketplace; they are thought to be easier for

consumers to process and retrieve from memory.

Sale written next to price: only if not overused
When to Use Price Cues:
Customers purchase item infrequently
Customers are new
Product designs vary over time
Prices vary seasonally
Quality or sizes vary across stores

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Steps in Setting Price

A firm must set a price for the first time when it develops a new product, when it introduces its regular
product into a new distribution channel or geographical area, and when it enters bids on new contract work.
The firm must decide where to position its product on quality and price.
o Example: In some markets, like the auto market, as many as eight price points or price tiers and levels
(Segments) can be found: Ultimate (Rolls-Royce), Gold Standard (Mercedes-Benz), Luxury (Audi),
Special Needs (Volvo), Middle (Buick), Ease/Convenience (Ford Escort), Me Too but Cheaper (Hyundai),
Price Alone(Kia)

Step 1: Selecting the Pricing Objective

Survival: When companies set survival as their major objectives, they set the price that covers variable costs

and some fixed costs to stay in business.

Maximum Current Profit: When companies use current profit maximization as their pricing goal, they choose

the price that will produce the maximum current profit or return on investment.
Maximum Market Share (market penetration strategy): Some companies want to maximize their market share.

They set the lowest price, assuming the market is price sensitive. The following conditions favor a low price:
o The market is highly price sensitive, and a low price stimulates market growth.
o Production and distribution costs fall with accumulated production experience.
o A low price discourages actual and potential competition.
Maximum Market Skimming: Setting a high price for a new product to skim maximum revenue layer by layer
from the segments that are willing to pay high price; the company makes fewer, but more profitable sales.
When the initial sales slowdown, and as competitors threaten to introduce similar chips. The company can
lower the price to draw in a new price-sensitive layer of customers. Market skimming makes sense under the

following conditions:
o A sufficient number of buyers have a high current demand.
o The high initial price does not attract more competitors to the market.
o The high price communicates the image of a superior product.
Product-Quality Leadership: Many brands strive to characterize by high levels of perceived quality, taste, and

statue with a price just high enough not to be out of consumers reach.
Other Objectives: Nonprofit and public organizations may have other pricing objectives. Universities aim for
partial cost recovery. Gifts and public grants to cover the remaining costs.

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Step 2: Determining Demand

Each price will lead to a different level of demand and therefore have a different impact on a company's
marketing objectives. The relation between alternative prices and the resulting current demand is captured in

a Demand Curve.
In the normal case, demand and price are inversely related:
o The higher the price, the lower the demand.
o In the case of prestige goods, the demand curve sometimes slopes upward. A perfume company raised
its price and sold more perfume rather than less! Some consumers take the higher price to signify a

better product. However, if the price is too high, the level of demand may fall.
Price Sensitivity:
o The demand curve shows the market's probable purchase quantity at alternative prices. It sums the
reactions of many individuals who have different price sensitivities. The first step in estimating
o

demand is to understand what affects price sensitivity.

Generally speaking, customers are most price sensitive to products that cost a lot or are bought
frequently. Companies, of course, prefer customers who are less price sensitive. Factors Leading to

Less Price Sensitivity:

The product is more distinctive
Buyers are less aware of substitutes
Buyers cannot easily compare the quality of substitutes
The expenditure is a smaller part of buyers total income
The expenditure is small compared to the total cost of the end product
Part of the cost is paid by another party
The product is used with previously purchased assets
The product is assumed to have high quality and prestige
Buyers cannot store the product
Estimate Demand Curves: Companies measure their demand curves using several different methods:
o Statistical Analysis of past prices, quantities sold, and other factors can reveal their relationships.
o Price Experiments can be conducted: to charge different prices in similar territories to see how sales
o
o

are affected. However, it must do this carefully and not alienate customers.
Surveys can explore how many units consumers would buy at different proposed prices.
In measuring the price-demand relationship, the market researcher must control for various factors
that will influence demand. The competitor's response will make a difference. Also, if the company
changes other marketing-mix factors besides price, the effect of the price change itself will be hard to

isolate.
Price Elasticity Of Demand:
o Marketers need to know how responsive, or elastic, demand would be to a change in price. If demand
hardly changes with a small change in price, we say the demand is inelastic. If demand changes
considerably, demand is elastic. The higher the elasticity, the greater the volume growth resulting from
a 1 percent price reduction. If demand is elastic, sellers will consider lowering the price. A lower price
will produce more total revenue. This makes sense as long as the costs of producing and selling more

o
o

units do not increase disproportionately:

Elastic Products: Lower price to maximize revenue
Inelastic Products: Higher price to maximize revenue
Elasticity Coefficient = (Change in Quantity of Demand)/(Change in Price)
Demand is likely to be less elastic under the following conditions:
There are few or no substitutes or competitors
Buyers do not readily notice the higher price
Buyers are slow to change their buying habits
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 Buyers think the higher prices are justified.

Step 3: Estimating Costs

Demand sets a ceiling on the price the company can charge for its product. Costs set the floor. The company
wants to charge a price that covers its cost of producing, distributing, and selling the product, including a fair

return for its effort and risk.

Types of Costs and Levels of Production: A company's costs take two forms, fixed and variable:
o Fixed Costs (also known as overhead) are costs that do not vary with production or sales revenue. A
o
o
o

company must pay bills each month for rent, heat, interest, salaries, and so on, regardless of output.
Variable Costs vary directly with the level of production. These costs tend to be constant per unit
produced. They are called variable because their total varies with the number of units produced.
Total Costs consist of the sum of the fixed and variable costs for any given level of production.
Total Costs = Fixed Costs + Variable Costs
Average Cost is the cost per unit at that level of production; it is equal to total costs divided by
production. Management wants to charge a price that will at least cover the total production costs at a

given level of production.

Average Costs = (Total Costs) / (Production Unit Sales)
Accumulated Production: Decline in the average cost with accumulated production experience is called the
experience curve or learning curve.
Activity-Based Cost Accounting:
o Companies try to adapt their offers and terms to different buyers instead of standard cost accounting.
o

ABC accounting tries to identify the real costs associated with serving each customer.
It allocates indirect costs like clerical costs, office expenses, supplies, and so on, to the activities that
use them, rather than in some proportion to direct costs. Both variable and overhead costs are tagged

back to each customer.

Companies that fail to measure their costs correctly are not measuring their profit correctly and are
likely to misallocate their marketing effort. The key to effectively employing ABC is to define and
judge "activities" properly. One proposed time-based solution calculates the cost of one minute of
overhead and then decides how much of this cost each activity uses.

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Target Costing:
o Costs change with production scale and experience. They can also change as a result of a concentrated
effort to reduce them through target costing. Market research is used to establish a new product's
o

desired functions and the price at which the product will sell, given its appeal and competitors' prices.
Deducting the desired profit margin from this price leaves the target cost that must be achieved. Each
cost element must be examined, and different ways to bring down costs must be considered. The
objective is to bring the final cost projections into the target cost range. If this is not possible, it may
be necessary to stop developing the product because it could not sell for the target price and make the
target profit.

Step 4: Analyzing Competitors' Costs, Prices, and Offers

Within the range of possible prices determined by market demand and company costs, the firm must take
competitors' costs, prices, and possible price reactions into account. The firm should first consider the nearest
competitor's price:
o If the firm's offer contains features not offered by the nearest competitor, their worth to the customer
o

should be evaluated and added to the competitor's price.

If the competitor's offer contains some features not offered by the firm, their worth to the customer

should be evaluated and subtracted from the firm's price.

Now the firm can decide whether it can charge more, the same, or less than the competitor. But competitors
can change their prices in reaction to the price set by the firm.

Step 5: Selecting a Pricing Method

Markup Pricing:
o The most elementary pricing method is to add a standard markup to the product's cost. Construction
companies submit job bids by estimating the total project cost and adding a standard markup for
o
o
o

profit. Lawyers and accountants typically price by adding a standard markup on their time and costs.
Unit Cost = Unit Variable Cost + (Fixed Cost)/ (Unit Sales)
Markup Price = (Unit Cost )/(1 - Desired Return on Sales)
Example:
Suppose a toaster manufacturer has the following costs and sales expectations:
Variable cost per unit $10 Fixed cost $300,000
Expected unit sales 50,000
The manufacturer's unit cost is given by:
Unit Cost = Variable Cost + (Fixed Cost)/ (Unit Sales)
Unit Cost = $10 + ($300,000)/(50,000) = $16
Now assume the manufacturer wants to earn a 20 percent markup on sales. The manufacturer's
markup price is given by:
Markup Price = (Unit Cost )/(1 - Desired Return on Sales)
Markup Price = ($16 )/ (1 - 0.2) = $20

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Target-Return Pricing:
o The firm determines the price that would yield its target rate of return on investment (ROI).
o Target pricing is used by General Motors, which prices its automobiles to achieve a 15 to 20 percent
o
o

ROI. This method is also used by public utilities, which need to make a fair return on investment.
Target-Return Price = (Unit Cost) + (Desired Return * Invested Capital ) / (Unit Sales)
Example:
Suppose the toaster manufacturer has invested $1 million in the business
And wants to set a price to earn a 20 percent ROI, specifically $200,000.
Variable cost per unit $10 Fixed cost $300,000
Expected unit sales 50,000
The target-return price is given by the following formula:
Target-Return Price = (Unit Cost) + (Desired Return * Invested Capital ) / (Unit Sales)
Unit Cost = Variable Cost + (Fixed Cost)/ (Unit Sales)
Unit Cost = $10 + ($300,000)/(50,000) = $16
Target-Return Price = = $16+ (0.20 X $1,000,000)/( 50,000) =$20
The manufacturer will realize this 20 percent ROI provided its costs and estimated sales turn out to be
accurate. But what if sales do not reach 50,000 units? The manufacturer can prepare a break-even
chart to learn what would happen at other sales levels. Fixed costs are $300,000 regardless of sales
volume. Variable costs rise with volume. Total costs equal the sum of fixed costs and variable costs.

The total revenue curve starts at zero and rises with each unit sold.
Break-Even Volume = (Fixed Cost)/ (Price - Variable Cost)

The total revenue and total cost curves cross at 30,000 units. This is the break-even volume. It can be
verified by the following formula:
Break-Even Volume = (Fixed Cost)/ (Price - Variable Cost) = ($300'000)/( $20-$10) = 30,000

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