Products and Pricing

In this lesson we will examine the first two elements of the Marketing Mix:  Products and Pricing.

1.  PRODUCT

A product (or service) is a basket of features – big, small, blue, pointed, long, covered, etc., that have benefits for the user.  As an example, features of a bottle opener are a shape that fits over a bottle top and a handle that can be gripped and/or pulled.  The benefits of these are that, when used properly, the tool will remove the bottle cap.  More features can be added – an ergonomic handle, a can opener at the opposite end, a corkscrew attachment – that have additional benefits – a more comfortable grip and the versatility to open cans or wine bottles.

A service also has features and benefits.  A maid service offers the feature of house cleaning, the benefit being that you don’t have to do it yourself.

Tangible vs. Intangible Features

Tangible features are easy to identify; they are those things you can see, touch, feel, smell, etc.  What can be equally important however, are intangible features such as the brand, the company name, or even the price.  Many people will not buy a generic (house brand) product because they believe there is greater benefit in a recognizable brand name product, such as Campbell’s Soup.  Some users are equally drawn to the company itself – Microsoft, IBM, Boeing, Nordstrom, Calvin Klein – and prefer products from these companies because the name itself implies certain benefits to the customer.

Price can also be a feature that imparts benefits to users.  A low price may cause the product to be perceived as a good value, while a higher price may imply high quality.  These are examples of how the elements of the Marketing Mix interact to complete the profile of the product.

Product Life Cycle

The features of a product that impart benefits are constantly changing.  Perhaps new technology develops that makes older models obsolete.  Maybe a competitor introduces a similar product made with different materials or colors that becomes more popular with consumers.  What often happens is that competitors find cheaper manufacturing methods which reduce costs, and offer the same product at lower prices.  All of these things work together to eventually cause a product to no longer be viable in the marketplace, and it is abandoned. 

The Product Life Cycle can be shown graphically:  first look at the upper red line, which represents total sales in dollars.

Dollars                    
                        Introduction       Growth            Maturity               Decline

                                  Time

Phase 1:  Introduction
In the Introduction Phase, the product is first being offered for sale in the market.  There is heavy advertising (another element of the Marketing Mix!) in order to increase sales.

Phase 2:  Growth
This is the period of rapid sales growth as more and more customers see our advertising or hear about the product through word-of-mouth.

Phase 3:  Maturity
During the previous rapid growth phase competitors began to notice our success, and more competitive products are now beginning to emerge.  At the same time, sales have slowed because many consumers have already purchased the product, so fewer new customers remain in the market.

Phase 4:  Decline
The product is no longer meeting the demands of the target market, who now have either satisfied their need for this product, or who are being drawn to competitor’s products because they are cheaper or have more new features than our original product.  Sales have begun to slow considerably.

How long is this cycle?  It varies for every product – clothing can have a six month life cycle, while a cement mixer may go decades before new features make the original obsolete.

 Profitability in the Product Life Cycle
The lower green line depicts profitability in dollars during the Product Life Cycle.

During the Introductory Phase there is little profit, as research and development expenses and advertising take most, or all, of the sales dollars. 

In the Growth Phase profit margins begin to grow as the company reduces costs by becoming more efficient in the manufacturing of the product.  At the same time, selling prices remain constant because no competitors have yet emerged.  Little advertising is needed to maintain sales momentum.

It is during the Maturity Phase that the greatest amount of profit occurs.  It is also at this phase, however, that competitors begin to see how popular and profitable the product is, and begin to introduce their own competing products.  In order to maintain sales momentum, the company must consider either more advertising or (more likely) reducing prices.  Profit margin begins to drop.

Finally, in the Decline Phase both of the above scenarios happen.  Competitors emerge with newer, better, or cheaper products, and the original company must advertise and lower prices to maintain sales.  Eventually, it is no longer profitable to produce the product, and it is discontinued.

2.  PRICE
As suggested above, pricing can be an important attribute of a product.  It is equally important that pricing of a product result in profitability for the company.  We will examine three concepts in pricing – pricing based on costs, pricing based on market, and the Break Even Analysis.

Cost-based Pricing
Simply put, this is the process of adding up all of the costs associated with the production of the product.  This includes all of the components – metal, plastic, nuts, bolts, paint, and packaging – and also the amount of labor required to make that one item.  There is then a profit margin added to the costs, and this can be based on what is typical in the industry, or for the particular company.  You can see that this might result in under-pricing if the market would accept a higher profit margin than the company selects.  Usually, Marketing Research is done so that a proper profit margin can be selected, as it is difficult to raise prices once the product has been introduced in the market.  Equally difficult is recapturing customer interest once the price is thought to be too high.

Market-based Pricing
Here, as suggested above, Marketing Research is used to establish what price is currently available in the market for this type of product.  It’s as if we took the product around all day at the Mall and asked everyone we saw “what would you pay for this?” and then averaged the result.  The key characteristic of this type of pricing is that it is not based on cost, except as a way of determining an acceptable price at the low end.  Usually, however, this type of pricing results in high margins because there are few competitors in the marketplace.

Break-even Analysis
In all companies there are two major types of expenses, fixed and variable.  (I use “cost” and “expense” interchangeably.)

 Fixed expenses are those that occur no matter how many widgets are produced.  These are things like rent, insurance, office salaries, and utilities.  A common name for this category of expense is overhead.

Variable expenses, as the name implies, vary according to how many widgets are made.  Each widget takes one blue thingy at $1, five round thingies at 50 cents, etc, and these are multiplied times the number of widgets made to get the variable material costs.  Labor can also be variable, because some workers are at work even when production is temporarily shut down, while others are brought in to work only when production is underway.

A total cost curve can be calculated using the Total Cost formula of: 

                Total Cost = Fixed Costs  +   N(Variable Costs)    Where N is the number of units produced. 

The Total Revenue curve can be drawn similarly, except that ALL revenue is variable.  Don’t sell any, you don’t have revenue.  The Total Revenue formula is as follows:

                Total Revenue = Number of Units Sold (N)  X  Selling Price

The slope (steepness) of the Revenue curve will be greater than the Total Cost curve because the selling price is going to be higher than the variable costs used to produce that one unit.

The key in break-even analysis is to find out where the two curves intersect; this is the Break-even point, where all fixed expenses are covered, and where profitability begins. 

As an example, if Fixed expenses are $10,000; Variable expenses are $10 per unit; and we are Selling the item for $15 each, the formula would be:

                                BREAK-EVEN    =            $10,000       =          $10,000        =        2,000 units
                                                                           ($15 - $10)                      $5

So, how long does it take to break even?  This analysis does not tell us how long in time, only when enough units are sold to reach break even.

Using Break-even Analysis in Pricing Decisions

• Scenario #1 – PENETRATION PRICING

The product has a very long Product Life Cycle, and there are competitors already in the market.    Price LOW.

In this case we would probably have to price low in order to compete in the marketplace, but we also know that if we can get into the market there will be a long period in which to make profits.  Pricing low means the green revenue curve above would flatten out to the right, making the break-even point further out to the right in units.  Paradoxically, break-even might be sooner in time because at the lower price we sell many more units.  In time, by pricing low, we hope to capture a significant part of the market.  We will be profitable, but if we can then lower our variable expenses we can increase our profitability further.

• Scenario #2 – SKIMMING

The product has a short Product Life Cycle, but there not yet competitors in the market.    Price HIGH.

In this case we would want to price high in order to capture profits before competitors emerge, and before the product becomes obsolete.  Pricing high means the green revenue curve above would become steeper, making the break-even point move to the left.  Profits would begin sooner, and would remain strong until it was decided to discontinue the product.

Want more information on Break Even Analysis?
http://www.businesstown.com/accounting/projections-breakeven.asp
http://www.bized.ac.uk/virtual/vla/break_even_analysis/
http://www.businessknowhow.com/startup/break-even.htm

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