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Chapter 11: Pricing

• Price: the assignment of value, or the amount the consumer must exchange to receive the offeringMoney, goods, services, favors, votes, or anything

else that has value to the other party

• Value = Benefits/Price Can include monetary and nonmonetary costs, and

opportunity costs

Steps in the Price Planning Process

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Step 1: Develop Pricing Objectives

• Sales or market share objectives• Profit objectives • Competitive effect objectives • Customer satisfaction objectives• Image enhancement objectives

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Step 2: Estimate Demand

• ForecastingHow much of a product are customers willing to buy

as its price goes up or down?

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The Price Elasticity of Demand

• How sensitive (responsive) are customers to changes in the price of a product?

• The percentage change in unit sales that results from a percentage change in price. When changes in price have large effects on the amount

demanded, demand is elastic When changes in price have little or no effect on the amount

demanded, demand is inelastic

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Relationship of TR to price elasticity

• ElasticPrice and total revenue

work in opposite directions.

If price goes down, quantity demanded goes up to a great extent so that TR increases.

Know flip side for price increase!

• InelasticPrice and total

revenue change in the same direction.

If price goes down, quantity demanded goes up, but only to a small extent; TR actually decreases

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Factors that Increase Elasticity of Demand

Non-necessities (pizza) generate elastic demand• We have to buy necessities regardless of price changes!

Availability of close substitute products facilitates elastic demand.

Cross (Price) Elasticity of Demand

Effect of price changes on one product on demand for other products.

• When price of one product goes up: (gas)– Demand for substitutes will increase (biofuels; nuclear;

wind)– Demand for complements will decrease (gas guzzling

vehicles)

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Total CostsSum of the Fixed and Variable Costs for a Set

Number of Units Produced

Total CostsSum of the Fixed and Variable Costs for a Set

Number of Units Produced

Step 3: Determine Costs

Fixed Costs

Costs that don’tvary with the

number of units produced.

Utilities,Equipment

Costs

Variable Costs

Costs of productionthat do vary with

the number of units produced.

Processed Materials,Raw

materials

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Break-Even Analysis

• A method to determine the number of units a firm must produce and sell at a given price to cover all its costs.

• Break-even point: point at which a firm doesn’t lose any money and

doesn’t make any profitAny unit a firm sells beyond this break-even quantity

will generate a profit.

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Step 4: Evaluate the Pricing Environment

• Review from Ch. 2/3 The economy

• Broad economic trends

• Recessions

• Inflation

The competition• Industry structure

Regulations: • Biofuel mandates

Consumer trends International influences (exchange rates, dumping, tariffs, etc.)

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Step 5: Choose a Pricing Strategy

• Pricing strategies based on cost Pros: Simple to calculate Cons: Fail to consider several factors (target market, demand,

competition, product life cycle, product’s image); difficult to accurately estimate costs

Example:

Break-even pricing;

Cost-plus pricing: total all product costs and add markup

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Step 5: Choose a Price Strategy (cont’d)

• Pricing strategies based on demandBased on estimate of quantity a firm can sell at

different pricesTarget costing (also known as demand-backwards

pricing): • Identify quality and functionality customers need and the price

they’re willing to pay (“sweet spot”) before designing the product.

Yield management pricing: • charge different prices to different customers to manage capacity

• often used by services, due to “perishability” (cannot “store” airplane seats or hotel rooms that go unused during non-busy periods)

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Step 5: Choose a Price Strategy (cont’d)

• Pricing strategies based on the competitionJM : Price based on value proposition/market positionPricing near, at, above, or below the competitionPrice leadership strategy: industry giant announces

price, and competitors get in line or drop out• Common in oligopoly

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Step 5: Choose a Price Strategy (cont’d)

• Pricing strategies based on customers’ needsValue pricing or everyday low pricing (EDLP): pricing

strategy in which a firm sets prices that provide ultimate value to customers.

Total cost of ownership (not in book): • Includes not only the price a customer pays for the product,

but also costs of maintaining and using the product over time – Energy efficient light bulbs– Automobiles (Consumer Reports)

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Step 5: Choose a Price Strategy (cont’d)

• New-product pricing (see next slides)Skimming price:

• a very high premium price

Penetration pricing: • a very low price

– to encourage more customers to purchase – to establish a barrier to entry

Trial pricing: • low introductory price for a limited period of time

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Reasons for Using a Skimming Price Strategy

Skimming Price - Charging a

High, Premium Price

Skimming Price - Charging a

High, Premium Price

Product Benefits that Customers Want at Any Cost.

Product Benefits that Customers Want at Any Cost.

Little Chance that Competitors Can Enter the Market Quickly.

Little Chance that Competitors Can Enter the Market Quickly.

Several Customer Segments with Different Levels of Price Sensitivity.

Several Customer Segments with Different Levels of Price Sensitivity.

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Penetration PricingA New Product is Introduced at a Very Low Price

Penetration PricingA New Product is Introduced at a Very Low Price

Discourages Competitors

FromEntering the

Market

Discourages Competitors

FromEntering the

Market

Reasons for Using a Penetration Price

Low Price Encourages

Demand and Salesin the Early Stages

of the Product Life

Cycle

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Step 6: Develop Pricing Tactics

• Pricing for individual productsTwo-part pricing: offering two separate types of

payments to purchase the productPayment pricing: breaking total price into smaller

amounts payable over time

• Pricing for multiple productsPrice bundling: selling two or more goods or services

as a single package for one priceCaptive pricing: pricing two products that work only

when used together

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Pricing and Electronic Commerce

• Online Pricing considerationsConsumers gain control

• Information/knowledge

Customers more price-sensitive.Consumers have more negotiating power.

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Pricing and Electronic Commerce

• Dynamic pricing strategies: Seller easily adjusts price to meet changes in

marketplace.• Cost of changing prices on Internet is practically zero.

Firms can respond quickly and frequently to changes in costs, supply, and/or demand.

• AuctionsTraditional: E-BayReverse

• Bots

“The Future of Business is Free”

• Freenomics:Give products away for free because of the increase

in profits that can be achieved by getting more people to participate in a market

• Example: Comcast gave 9 million subscribers FREE digital video recorders but made money on installation and monthly DVR usage fees

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Pricing and Consumer Behavior

• Interesting issues Internal Reference PricesPrice/Quality inferencesOdd-even pricingPrice lining

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Deceptive Pricing Practices

• Bait-and-switch – Consumers “lured” into store for a very low price, but

then the item is not available. A more expensive product is offered instead

Trading up is acceptable

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Unfair Sales Acts

• Laws or regulations prohibiting selling products below cost “minimum mark-up law” loss leader pricing (to build store traffic) (legal in some

states / not in others)

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Price Discrimination

• Means selling the same product to different wholesalers and retailers at different prices (or offering different incentives, i.e., cooperative adv.)

• Regulated by Robinson-Patman Actonly applies to resellersdiscounts are legal if based on established policy and

offered to any customer who chooses to buy under those conditions

legal if “proportionate to sales volume”

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Price Fixing

• Occurs when two or more companies conspire/collude to keep prices at a certain levelHorizontal price fixing: when competitors making the

same product jointly determine what price they each will charge

Vertical price fixing: when manufacturers attempt to force the retailer to charge the suggested retail price

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Predatory Pricing

• Means that a company sets a very low price for the purpose of driving competitors out of business