Ch. 10.doc

CHAPTER TEN MANAGING PERCEIVED COSTS Key Points The purpose of this chapter is to examine the nature of costs and pricing. Nonprofit marketers are challenged to influence exchanges, and from the target audience’s viewpoint, those exchanges involve trading benefits for costs. Perceived costs are any expected negative consequence of a proposed exchange considered by the target audience member. Costs can be monetary, non-monetary, or mixed. Non-monetary costs include psychic pain, the need to change old habits or ideas, expenditures of time and energy and dislocations of social arrangements. Nonprofit managers need to recognize the “duality” of costs. In an exchange, what is a benefit for one side of the exchange is typically a cost for the other. The manager faces interesting challenges in keeping some costs high enough to assure continuing revenues (and survival) for the organization, while other costs must be reduced as much as possible to lower the barriers of target audience involvement or action. Based on the “duality” of costs, the organization bears a cost in order to reduce any of the cost to the target audience, so it must assess the relative responsiveness of the audience and value of each considered cost reduction In developing a pricing strategy, the organization must first set pricing objectives. The can include: surplus maximization, cost recovery, market size maximization, social equity, or market disincentivization. The organization’s specific strategy to meet these pricing objectives may be primarily cost oriented, demand oriented, or competition oriented. Chapter Outline The nature and role of costs Perceived costs The duality of costs Costs management Understanding costs Practical management of the cost bundle Setting money process Setting the pricing objectives Surplus maximization Cost recovery Market size maximization Social equity Market disincentivization Choosing a pricing strategy Cost-oriented pricing Value-based pricing Competition-oriented pricing Ethical challenges to pricing Varying costs across segments Promotional pricing Vignette: Social Marketing and the role of “costs” Jeffrey Sachs, of Columbia University, advocates against the use of business practices in social problems environments, such as fighting poverty in third-world countries. He rails against what is often referred to as “social marketing” – charging nominal costs to the poor in order to create implied value. Sachs indicates that where social marketing has been applied, “it has failed repeatedly” as in cases of sales of anti-malarial bed nets and contraceptives. “They have been unrealistic about what the poor can actually afford to pay, which is usually little or nothing.” Counter arguments indicate, at least anecdotally, that the poor often view such products as “not so good if they are free.” The authors use this argument and counter-argument to point out the different between “costs” and “cost,” the latter being applied in a literal sense, without the understanding that the poor may pay social or psychic, or other non-monetary costs, even to take a “free” product or service. Chapter Summary Members of a target audience balance the expected benefits form an action against the expected costs. There are non-monetary costs in terms of psychic costs, or physical energy or effort. A perceived cost is any expected negative consequence of a proposed exchange considered by a target audience member. In many nonprofit exchanges, managing perceived costs could be more important than managing the perceived benefits because it is the costs that keep people from behaving as the marketer desires. The monetary price may be the least important component of perceived cost. Costs have a “duality” in that in an exchange, what is a benefit for one side of the exchange is typically a cost for the other. Minimizing non-monetary costs to increase the level of exchanges is balanced with maximizing economic costs (the price) to increase profits to levels required to ensure survival or growth of the organization. There is a constant strategy of “trade-offs” in such a circumstance where increases in non-monetary costs may be initiated to increase monetary savings (such as a transit authority reduces routes or schedules in order to save money – causing riders to wait longer), or monetary costs may be raised in order to reduce non-monetary costs and still ensure profitability, such as when a hospital charges more for a private room. An optimal cost management strategy is to maximize the number of exchanges (or revenue) for a given cost. The marketer must research target audience perceptions of their costs – particularly those non-monetary costs. Determining what the perceived costs are helps the marketer develop strategies and determine what marketing expenses must be incurred in order to reduce target audience perceived cost. Target audience response to an offer represents a reaction to a bundle of costs and a bundle of benefits. The difficulty often arises in determining which costs to reduce and by how much. These decisions require knowledge of a relative target audience response at a given expense level and which change in cost(s) would yield the largest gain in the number of exchanges. For example a medical clinic may seek to reduce waiting time, improve the appearance of unattractive surroundings, reduce form-filling-out time, or reduce parking costs, but must decide what the costs are to the organization in order to reduce those costs to the target audience, and examine the relative value. Will a patient pay more for the doctor’s visit, in order to have his or her parking ticket validated – giving the appearance of “free” parking, or will the doctor’s office have to “eat” those costs in order to get more patients to select that location? An organization should determine its pricing objectives and pricing strategies. Five pricing objectives can be distinguished: surplus maximization, cost recovery, market size maximization, social equity, and market disincentivization. Surplus (profit) maximization begins with an estimate of the response (demand) function and the cost function. Then, demand and cost equations are combined with total revenue and total surplus equations to find the surplus maximizing price. This model does not calculate and account for things like preference for increased surplus over the long term, the way other parties might respond, government price ceilings, the effect of other marketing mix elements and inaccuracies in the demand and cost functions. Many nonprofits set a price to recover a reasonable portion of the costs while others seek a full cost recovery. Some nonprofits seek to create market size maximization, such as trying to maximize the total number of service users – thus “making it up in volume.” A low price normally stimulates higher usage and may elicit more revenue in the long run. Organizations may price their services to contribute to social equity, such as when charging more for services used by the well to do than for those used mostly by the poor. Market disincentivazation pricing discourages peopling from purchasing a product or service (e.g. government taxes on cigarettes designed to reduce sales). After a pricing objective is set, a nonprofit can select from several pricing strategies. These are: cost-oriented, value-based, and competition-oriented or promotion-oriented pricing. There are several approaches to cost –oriented pricing. “Mark-up” pricing adds pre-determined but different mark-ups to various goods (e.g. museum gift shops). The “cost plus” method is useful for jobs that are non-routine and difficult to price in advance (e.g. market research). Some nonprofits, such as symphonies, charge less than their costs, resulting in cost-minus pricing. The most popular form of cost-oriented pricing uses break-even analysis, which determines for any proposed price, the number of units that must be sold to cover the costs fully. Cost-oriented pricing is popular because it is simple to administer, minimizes price-competition, and is fair to both buyers and sellers. Value-based pricing rests on the premise that price should reflect the target audience’s perceptions of perceived value. A corollary is that an organization should invest in building up the perceived value of an offer if it wants to charge a higher price. One difficulty with value-based pricing is that it can be difficult to determine what the target audience will pay, particularly for new-to-the-world offerings or those with intangible consequences. Another problem is that the benefits may be extremely desirable, even life-saving, but ethical considerations or social costs may drive the nonprofit to charge far below the perceived value (e.g. AIDS medicine). Competition-oriented pricing sets prices based on what competitors are charging (i.e. the going rate) and not with regard to an organization’s own costs or demand. Sometimes, nonprofit organizations have difficult challenges because segments, or certain groups within society have strong ethical feelings about what is a “fair price” for a given product or service, such as the idea that certain libraries or museums should be free or parks created by taxpayer dollars should have limits to what they can charge for admission. Another approach involves varying costs across segments. This kind of price discrimination varies consumer monetary costs based on the cost of provision, matching the price to the perceived value received, regulating demand, and capturing the most surplus the target audience is willing to pay. Promotional pricing maintains a list price, but introduces price specials to stimulate increased buying. Teaching Suggestions Continue to attempt to vary the lecture environment and style and introduce variance into the reading assignments and reading assessment to reinforce traditional retention. Assign different students each week to lead a discussion of the questions at the end of each chapter. Continue to try to find new ways to incorporate visual and audio elements into the class. To demonstrate the concepts of pricing — have students identify a nonprofit product or service in the community, or even something that doesn’t exist, and work through the steps – on paper – to price the product or service, using the different pricing methods. Consider assigning different group s to different pricing objectives and strategies and having the groups report back to the class. Discuss why all the prices are not alike, what challenges the students faced in the different pricing methods, and which method they “liked” for the chosen nonprofit service or product. Frequent discussion helps to illustrate key points – discussion of text points can lead to the next text point or key learning. Possible discussion points for this chapter include: Review the concept of response functions, and then discuss how target audience responses are actually responses to bundles of costs and benefits. Then discuss (Fig. 10-1 – Responses to expenditures on reducing consumer costs) Hoes does this help determine which marketing expenditures to make? (It indicates which kind of target audience cost a level of marketing expenditure will affect and measures the gain in volume of exchanges the that the expenditure will achieve. This shows how to find the largest net gain.) Present the financial model shown for surplus maximization and finding the surplus maximizing process (p 239). What are the practical limitations of this method? Using the concept of break-even analysis, (p 243), discuss the cost-oriented pricing strategy. Have students explain the summer camp illustration in the chapter. Discuss ethical challenges in nonprofit product or service pricing (p245). What kinds of services or products face greater ethical challenges? Are there organizations that have successfully or unsuccessfully fought this ethical challenge? How did they do what they did, and what was the end result? Short Answer Questions Describe the five pricing objectives Surplus Maximization — four equations comprise the surplus maximizing pricing model, which focuses on yielding the largest possible surplus or profit for the organization. Cost Recovery — a portion of the costs or the full costs are recovered Market Size Maximization — nonprofits maximize the number of users, making up for lower margins with volume Social Equity — services are priced to contribute to social equity (e.g. subsidized services for the poor) Market Disincentivization — pricing discourages people from purchasing a product or service (e.g. government tax on cigarettes) Describe the four pricing strategies Cost-oriented— mark-up pricing, cost-plus, cost-minus, and break-even analysis Demand –oriented—rests on the premise that price reflects the target audience’s perceived value Competition-oriented— pricing based on what competitors are charging (i.e. the going rate) Promotional pricing— Temporary deductions or discounts from a maintained list price with promotional specials Describe the strategy of varying costs across segments by price discrimination An offer of products and services at different prices Varies target audience monetary costs based on the cost of provision, matching the price to the perceived value received, regulating demand and capturing the most surplus the target audience is willing to pay. Describe the conflicts of ethical price setting Nonprofits may face challenges from the public or segment of the public who feel that a certain price is “fair” or “unfair” for a given product or service based on ethical commitments to society The argument is almost always tied to services which the public has historically viewed as a “right” based on a history of “free” pricing because of the relationship with government or other nonprofit such as a church. Examples include libraries charging to loan out books, government sponsored museums charging fees for attendance, city or government parks charging for use of the park, and “fair pricing” to the poor for social and health services. Multiple Choice Questions At a medical check-up, the fear that a disease will be found is a a. monetary cost b. perceived cost (Easy, p 234) (AACSB – Reflective Thinking) c. social cost d. physical cost e. dual cost A hospital may require a patient to walk-in for a simple outpatient surgery instead of admitting him or her to the hospital overnight to a. minimize the surplus cost to the patient b. increase the non-monetary costs to the patient (Moderate; p 237) (AACSB – Reflective thinking) c. increase the duality of costs to both parties d. practice market disincentivization e. reduce patient waiting time Understanding target audience perceptions of cost is important because a. strategies can be used to reduce perceived costs (Easy; p 234) b. target audience perceptions are always right c. a marketer wants to minimize the number of exchanges d. a perceived cost is the same as monetary cost e. costs only accrue to the target audience so you need to understand them The two stages an organization should go through when deciding on monetary pricing are a. determining demand functions and conducting a break-even analysis b. determining the demand and then the response functions c. determining the pricing objective and then the pricing strategy (Moderate; pp 237-238) d. determining the perceived cost and then the monetary cost e. determining the benefit bundle and then the cost bundle A local symphony has figured, through local demand analysis that for every $1 increase in the price of its ticket, there will be a corresponding drop of 100 fewer tickets sold. If the fixed cost of a production is $100,000, the cost of each performance is $10,000 and the cost for attracting each person attending is $10. The symphony is examining five price points -$30, $35, $40, $45 and $50. The symphony historically priced its tickets at $40 and averaged attendance of 6,000 over the course of six shows. The theater’s capacity is 10,000 over the six-show run. Which price offers the optimum price point for the symphony? a. $30 ($0 profit) b. $35 ($12,500 profit) c. $40 ($20,000 profit) d. $45 ($22,500 profit) (Difficult; pp 238-239) (AACSB – Analytical Thinking) e. $50 (20,000 profit) 6. When toll roads make customers pay part of their costs, the pricing objective is called: a. market size maximization b. market disincentivization c. social equity d. surplus maximization e. cost recovery (Easy; p 240) (AACSB – Reflective Thinking) Mass transit companies wishing to discourage commuting during rush hours and charge a higher price during these hours, the pricing objective is called: a. market size maximization b. market disincentivization (Easy; p 241) (AACSB – Reflective Thinking) c. social equity d. surplus maximization e. cost recovery Higher rates are charged for library services used by more affluent borrowers, such as DVD rentals, the pricing objective is called: a. market size maximization b. market disincentivization c. social equity (Easy p 241) (AACSB – Reflective Thinking) d. surplus maximization e. cost recovery The pricing strategy where theaters offer lower-priced tickets for students is called: a. Cost-plus pricing b. Cost-minus pricing c. Mark-up pricing d. Varying costs across segments (Moderate; p 245)(AACSB – Reflective Thinking) e. Competition-oriented pricing The pricing strategy where theaters offer attendees five plays for the price of four is called: a. competition-oriented pricing b. promotional pricing (Easy p 246-247) (AACSB – Reflective Thinking) c. varying costs across segments d. mark-up pricing e. cost recovery pricing 95