Pricing

The Meaning of Price

we generally think of price in monetary terms

what it costs us to acquire something of value

the costs may be monetary or non-monetary
What is Price?

Price and the Marketing Mix:

 Only element to produce revenues
 Most flexible element
 Can be changed quickly
Pricing Objectives

a firm may have several pricing objectives

 to achieve a certain return on sales

 to maximize short-term or long-term profits
 to increase sales to a certain level
 to achieve a target share of the market
 to maintain price stability in the market
 to meet competitors’ prices
 to indicate a particular positioning
Definition

Price
 The amount of money charged for a
product or service, or the sum of the
values that consumers exchange for
the benefits of having or using the
product or service.
The Customer Wants Value

price is not always an important factor in

influencing a sale; the customer wants more than a
low price, may be willing to pay more

the customer considers what he or she gets for the

price paid; the seller must offer value

what causes them to conclude that they “paid too much” or

“got a great deal”?
Pricing Orientation

Cost oriented – focus on business’s expenses

Profit oriented – focus on profit

Demand oriented – focus on consumer preference

Competition oriented – focus on the marketplace players

Cost Orientation

• Cost-Oriented Approaches
 Standard Markup Pricing
add the standard industry fixed % to my costs. Easy
to implement.

 Cost-Plus Pricing
add a standard dollar amount to my costs- like $5.00
for shipping and handling.
Mark-Up Pricing by Retailers and Wholesalers

Price = unit item cost

(1- mark-up)
Costs and Break-Even Analysis

break-even analysis is not a pricing strategy, but can

offer useful information

cost is viewed as a floor under a firm’s price

the break-even point is where total revenue equals

total costs; will be different for each price -- lets a firm
see what it will need to sell
Estimating Costs

Fixed costs - are those costs that do not

vary with production or sales revenue.

Variable costs - are those costs that vary
directly with production.

Total costs = Fixed Cost + Variable Cost
(for a given level of production.)
Examples of Fixed and Variable Costs

FIXED COSTS VARIABLE COSTS

Manufacturing plant and equipment Equipment servicing costs

(in a business selling product)

Office buildings Energy costs

Cars and other vehicles Fuel expenditure

Salaries Overtime and bonus payments

Break-Even Analysis

Assumptions:

total fixed costs are constant

variable costs remain constant per unit of

output.

B/E = Total Fixed Costs
Price - Average Variable Costs
Demand Orientation

 Skimming Pricing – high initial price

 Penetration Pricing – low initial price

 Prestige Pricing – high price = quality and status

 Target Pricing-make product fit price market will pay

 Yield Management Pricing – peak and non peak prices

New Product Pricing

Skimming price - firm charges a high, premium
price for its new product with the intention of
reducing it in future
 product is distinctive and
 demand inelastic

Penetration pricing - new product is introduced
at a very low price
 deter competition
 demand is elastic and competition is expected

Trial pricing - product carries a low price for a
limited time period
 When To Skim And When To Penetrate
Conditions For Effective Skim Pricing
• Need to recover R&D investment
quickly
• Demand is likely to be price-inelastic
• Unknown elasticity of demand - safer
to offer a higher price and then lower it,
than offering a lower price and try to
increase it
• High barriers to entry within the
market
• Few economies of scale or experience
• Product life cycles are expected to be
short.
Conditions For Effective Market
Penetration Pricing
• Strong threat of competition
• Product/service is likely to exhibit a
high price-elasticity of demand in the
short term
• Substantial savings from volume
production
• Low barriers to entry
• Life cycles are expected to be long
• Economies of scale and experience
exist to take advantage of.
Prestige Pricing: Demand Curves

Shows the quantity of a product that customers will

buy in a market during a period of time at various
prices if all other factors remain the same

Vertical axis represents the different prices a firm
might charge

Horizontal axis shows the number of units
Target Pricing

Target cost is the cost that can be incurred while

still earning the desired profit
 Selling price – desired profit = target cost

The customer sets the price

 Profit must be achieved through cost control
Achieving the Target Cost

Must include the features the customer wants while

maintaining cost at or below target

 Want to meet the customers needs, but not exceed them

Eliminating desired features will result in an undesirable product

Adding unwanted features will increase cost

 Failing to keep cost at or below target will result in

unacceptable profits
Target Costing Process

Two stage process

 Establish the target cost

Market research (to establish target price)

Product planning, concept development stages

 Achieve the target cost

Value engineering, continuous improvement

Design stage
 Continuous improvement in later stages
Bundle Pricing

bundling (package tie-in sale) - a type of tie-in sale in

which two goods are combined so that customers
cannot buy either good separately.

 bundling a pair of goods pays only if their demands are

negatively correlated.
Price discrimination

Price discrimination - practice in which a firm

charges consumers different prices for the same
good
Why Price Discrimination Pays

A price-discriminating firm earns a higher profit

from price discrimination because:

 it charges a higher price to customers who are willing to

pay more than the uniform price, capturing some or all
of their consumer surplus

 it sells to some people who were not willing to pay as

much as the uniform price.
Who Can Price Discriminate

Three conditions:

 a firm must have market power.

 consumers must differ in their sensitivity to price, and a

firm must be able to identify how consumers differ in this
sensitivity.

 a firm must be able to prevent or limit resale

Perfect Price Discrimination

multimarket price discrimination (third degree price

discrimination) - a situation in which a firm charges
different groups of customers different prices but
charges a given customer the same price for every
unit of output sold
Multimarket Price Discrimination with Two
Groups

Copyright gives Warner Home Entertainment the

legal monopoly to produce and sell the Harry Potter
DVD movie set.

 Warner engages in multimarket price discrimination by

charging different prices in various countries because it
believes that the elasticities of demand differ compared
to the U.S. price
Types of Price Discrimination (cont).

quantity discrimination (second-degree price

discrimination) - situation in which a firm charges a
different price for large quantities than for small
quantities but all customers who buy a given
quantity pay the same price
Types of Price Discrimination

perfect price discrimination (first-degree price

discrimination) - situation in which a firm sells each
unit at the maximum amount any customer is
willing to pay for it, so prices differ across
customers and a given customer may pay more for
some units than for others
Yield/Revenue Management

Integrated management of capacity and pricing

 Objective: maximize revenue (minimize lost revenue /

opportunity costs)

 “Science of squeezing every possible dollar from customers”

Profit Orientation
 Target Profit Pricing-set annual dollar volume or profit
If I need to make Rs. 5000, & I can make 5 units,
selling price is Rs.1000.

 Target Return-on-Sales Pricing-

Want to receive 1% of sales as my profit – actors & directors

 Target Return-on-Investment Pricing – Rationale for Mark-up

I can make 5 % on my money in the bank. Set price so

I make 6% on my investment if I invest it in my business.
Competition Orientation
 Above-, At-, or Below-Market Pricing
Use largest competitor as a benchmark to set your price.
 Cooperative pricing
 monopolistic competition
 recognize a common interest
 Adaptive pricing
 small firms take prices set by large firm
 Loss-Leader Pricing-
Price below cost to lure buyers in
Want buyer purchasing other things you sell at high mark ups
Loss Leader Pricing

Goods/services deliberately sold below cost to
encourage sales elsewhere

Purchases of other items more than covers ‘loss’ on
item sold

is not illegal unless it persists for a long time with the goal of
eliminating competition (predatory pricing)
Competition Orientation

Predatory pricing
a firm use low price attempting to punish another
firm or drive it out of business

Limit pricing
Discourage the entry of potential competitors
Understanding Pricing Game

Incentives for undercutting price
 Evil intention

extra market share and opportunistic profit if not immediately
retaliated by competitors
 especially true for industries with high fixed cost and peak seasons

 Good intentions

A firm strategically changes the way business is done

A firm offers additional feature without increasing price

A firm overreacts to a competitor’s limited and focused price
reduction with an across-the-board price reduction

 If you cut price for good intentions, make sure your

competitors do not misinterpret your intentions
 Communication & Price War

Legally “communicate” with your competitors to avoid price war

 Reveal that your intention of price cut is temporary and not

threatening

excess inventory

over capacity

future growth of the market

introduction of a simple version of the existing product

 Reveal your capability of fighting a price war

cost advantage

willingness to fight back

 Pre-announce price increases in future

Price War

Price war is “negative-sum” game

 Economic disaster

Difficult to increase profits by reducing price
 Coca-Cola, 1% reduction means $20million reduction in operating profit

No gain if immediately retaliated by competitors

Cutting price rarely drives competitors out of business

 Psychological trauma

Lower consumer reference price

Reduce consumer sensitivity to quality

Train loyal consumers to switchers

 Depending on how competitors interpret your move, your

price cut that boost sales today will radically change the
industry you compete tomorrow! That change is forever.
Take-away

Price war is a “negative-sum” game. In the long-run, it hurts every

players in the industry.

Winning price war requires

 Step 1: develop long-term plans (to prepare for future price war)
 Step 2: diplomatically communicate with your competitors (to avoid price war)
 Step 3: wisely choose confrontation (to win price war)

Decision on initiating or matching price cut should be made based

on long-term consequence
Thank You