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Chapter 11: Pricing
Agenda:
Discuss the chapter
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Pricing is Everywhere
You pay rent f or your apartment, tuition f or your education, and a fee to your dentist or physician.
The airline, railways, taxi and bus companies charge
you a fare
The local utilities call their price a rate
The local bank charges you interest f or the money youborr ow.
The guest lecturer is paid an honorarium
The government official takes a bribe to pass a lawwhich was his job anyway.
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Pricing Brings In the Revenue
Pricing is the only element in the marketing mixthat brings in the revenues (all the rest are costs)
Pricing is the easiest of the 4 P¶s to change
Price affects consumer demand
Price communicates the value of the pr oduct
(and often ser ves as a signal f or quality)
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Steps in the Price Planning Process
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Step 1: Develop Pricing Objectives
Increase Salesor Market Share
Gain as much market share as possible. Price wars,penetration pricing. Common in competitive industrieswhere consumers perceive small differences in pr oducts:(Verizon, Sprint)
Obtain a certain
level of Pr ofits
Commonly used when firm wants to recover its investmentin a short period of time (fads to premium/prestige pr oducts)
(a high price, skimming strategy)
Objective
CompetitiveEffect
Price is intended to reduce effectiveness of competitorseff orts. Typically set at or below the competition(Southwest Air in Den ± to beat out United)
Customer Satisfaction
Image Enhancement Common with prestige pr oducts ± give the consumer the perception of high status. Use skimming pricing
Focus is on pr oviding consumers with value. For example,Saturn¶s (value) no haggle pricing (value is determined byconsumer)
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Step 2: Estimate Demand
How much will people buy if the price goes up or down?
Examples of products that operate
on an elastic demand curve?
Examples of products that operate
on an inelastic demand curve?
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Determining Price Elasticity of Demand
E =% change in price
% change in demand
If the absolute value of E is < 1.0, price is inelastic
If the absolute value of E is > 1.0, price is elastic
Price Elasticity
A measure of sensitivity of consumers to changes in price
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Determining Price Elasticity of Demand(% change in demand/% change in price)
When analyzing price elasticity, you are concerned withthe absolute value, so ignore negative values
Elastic Demand 1 Elastic Demand 2 Inelastic Demand
Price Change
Demand Change
10 to 9 = 10%
27 to 31 = 15%4/27 = 15%
Elasticity 15%
-10%= -1.5
2.98 to 3.06 = 2.7%
1/10 = -10% .06/2.99 = 2.7%
30 to 27 = -10%3/30 = -10%
10%
-2.7%= -3.7
10 to 9 = 10%
1/10 = -10%
27 to 28 = 3.7%1/27 = 3.7%
3.7%
-10%= -.37
If the absolute value of E is < 1.0, price is inelastic
If the absolute value of E is > 1.0, price is elastic
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Price Elasticity andCross Elasticity of Demand
Factors that affect elasticity:
availability of substitutesVS.
substitute pr oducts
if price increasesf or bananas
demand may increasef or apples
complimentary pr oducts
if price increases
f or h
ot dogs
demand decreases
f or h
ot dog buns
C ross elasticity of demand
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Step 3: Determine Costs
Fixedcosts
Variablecosts
Totalcosts
Do not vary with
pr oduction or sales
levels
Rent Heat
Interest
Executive salaries
Vary with the level of
pr oduction
Packaging Raw materials
Sum of the fixed and
variable costs f or any
given level of pr oduction
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Breakeven Analysis
A method f or determining the number of units that a firm must sell
at a given price to cover all of its costs (fixed and variable)
Q(BE) =Fixed Costs
Price ± Variable Costs Per Unit
Assume Fixed Costs = $56,000 Assume Variable Costs = $20/unit
PriceQuantityDemanded
TotalRevenue
TotalF-Costs
TotalV-Costs
TotalCosts
Break-EvenQuantity Pr ofit
$76 1,000 $76,000 $56,000 $20,000 $76,000 1,000 $0
$80 1,000 $80,000 $56,000 $20,000 $76,000 933 $4000
$90 900 $81,000 $56,000 $18,000 $74,000 800 $7000
1. Q(BE)56,000
76-20= 1000 2. Q(BE)
56,000
80-20= 933 3. Q(BE)
56,000
90-20= 800
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Step 4: Evaluate the Pricing Environment
External (uncontr ollable) Factors to Consider When Setting Prices
1. The Economy
Recession: consumers are price-sensitive, switch brands
look f or the best price.
Inflation: prices and cost of living rise while money loses itspurchasing power (because cost of goods escalate). Here,customers are more insensitive to price increases.
2. The Competition
Oligopoly: small number of suppliers contr ol the market (airlines,
beer companies, wireless pr oviders). Price at the competition.
Monopolistic competition: many sellers who pr oduce similar pr oducts (toothpaste, jeans, restaurants). Focus on non-price
competition (features and benefits dictate price).
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Step 5: Choose a Pricing Strategy
Based on Demand (estimate demand at different prices):Target Costing & Yield Management
Based on Cost: Cost Plus Pricing
Based on Competition: Price Leadership
Basedon Cust
omer Needs: Value Pricing & EDLP
New Pr oduct Pricing: Price Skimming & Price Penetration
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Step 5: Choose a Pricing Strategy
Based on Cost: Cost Plus Pricing
Cost-plus pricing adds a standard markup to the cost of the pr oduct
Markup Pricing
Price = f (unit cost + desired markup)
Zappos desired markup on cost = 180% $52(1.80) = 94
Cost to Consumer? $52 + $94 = $146
MU on Cost: 9452
= 180% MU on Sell price: 94146
= 64%
Assume: unit cost of Joe¶s jeans = $52
Joe¶s Jeans
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Step 5: Choose a Pricing Strategy
Based on Cost: Cost Plus Pricing
Benefits
± Simple
± Resellers (e.g., Zappos) are certain about costs
± Price competition (among resellers) is minimized (becausemark-up is standardized)
Disadvantages
± Ignores consumers¶ perception of value
± Ignores demand (if mark-up too high, demand may fall)
± Ignores competition (e.g., Levi, Gap, Diesel)
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Step 5: Choose a Pricing Strategy
Based on Demand (estimate demand at different prices):Target Costing & Yield Management
Target Costing: (TC = Anticipated selling price ± profit margin)
Uses marketing research to identify the cost of pr oducing a pr oductf or a certain market-buyer before the pr oduct is designed
Boeing customer requested heated floors. In order
to cover costs and make a reasonable profit, Boeing
estimated that the anticipated selling price would
be greater than $1million. The customer then declined.
First determine price, then work backward to design and pr oduce the
pr oduct, which will still pr oduce a desired pr ofit
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Step 5: Choose a Pricing Strategy
Based on Demand (estimate demand at different prices):Target Costing & Yield Management
Yield management (also known as revenue management)
Understanding, anticipating, and influencing consumer behavior
in order to maximize revenue or pr ofits fr om a fixed, perishable
pr oduct (such as airline seats or hotel r oom reser vations).
Off -peak fares vs. peak-fares
(same routes, different $)
Results in price discrimination: charging different customers
different prices f or the same g
oodor ser
vice
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Step 5: Choose a Pricing Strategy
Based on Competition: Price Leadership
Tacit collusion (implied agreement) whereby one firm in an oligopolistic
industry sets a price (general industry price) with other firms f ollowing suit
United Airlines may set a standard off -peak
fare (between destinations) and all other
airlines follow suit
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Step 5: Choose a Pricing Strategy
Basedon Cust
omer Needs: Value Pricing & EDLP
Value Pricing
Intr oduced in the 1990¶s
Originator of the concept is believed
to be Taco Bell
Give customers more value than they
expect f or the price paid
Not the same as penetration pricing, which
implies low price alone. Value pricing relates
to customer expectations (give more than
they expect f o
r price paid)
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Step 5: Choose a Pricing Strategy
Basedon Cust
omer Needs: Value Pricing & EDLP
Everyday Low Pricing (EDLP)
Pr omises consumers a low price without
the need to
wait f or sale price e
vents
EDLP saves retail stores the eff ort and
expense needed to mark down prices, and
to pr omote ³sale events´
Believed to generate shopper loyalty.
Used heavily by Wal-Mart,
Pr o
cter & Gamble,W
inn-Dixie
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Step 5: Choose a Pricing Strategy
New Pr oduct Pricing: Price Skimming & Price Penetration
Price Skimming
Firm charges a very high, premium price f or new pr oducts in theintr oductory stage of PLC
When rival pr oducts enter, firm then lowers price to be competitive
Focus is on a pr ofit objective
Appr opriate strategy when:
pr oduct has unique benefits (Rolex)
when there is a str ong price-perceived quality benefit (wine)
little chance of competition in the near future (iPad?)
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Step 5: Choose a Pricing Strategy
New Pr oduct Pricing: Price Skimming & Price Penetration
Price Skimming
Apple used a price skimming strategywhen it intr oduced the iPhone in July, 2007
Company charged $599, making it themost expensive phone on the market.
In September, Apple dr opped the priceto $399 ± causing some consumers towant an iPology.
The 2 months of $599, helped Appleto recover R&D costs and make a pr ofit
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Step 5: Choose a Pricing Strategy
New Pr oduct Pricing: Price Skimming & Price Penetration
Price Penetration
Firm charges a very low price f or new pr oducts (in the intr oductory
stage of PLC) to sell more in a short period of time
Objective is to gain market share
Used to discourage competitors fr om entering the market
Apple used a penetration strategy
when introducing music downloads
(for $0.99/song)
Some customers were angered when
some songs started selling for $1.29
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Step 6: Develop Pricing Tactics
For Multiple Pr oducts
Selling two or more goods or ser vices as a single package f or one price
The single price is typically less than the total price of the items if purchased separately (³whole is less than the sum of its parts´)
Samsung Home Theater System:
Blue Ray DVD
3D-ready
Internet connectivity
Built-in WiFi
2 towers plus wireless rear satellite speakers
iPod and iPhone dock
Product Bundling
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Step 6: Develop Pricing Tactics
For Multiple Pr oducts
Pricing f or two items that must be used together
One item is priced low, and the other, which is essential to theoperation of the first, is priced very high
Captive Pricing
Razor: $4.95 Blades: $35.00
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Step 6: Develop Pricing Tactics
For the Trade
Trade or FunctionalDiscounts
Manufacturer (Coke) gives reseller (Price Chopper) a set
percentage discount off the list price (the suggested retail price
f or the end consumer to pay)
Given to resellers f or:
marketing the manufacturer¶s pr oducts (e.g., in-store pr omotions)
storing the manufacturer¶s pr oduct
transporting the manufacturer¶s pr oduct (to all of resellers¶ stores)
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Step 6: Develop Pricing Tactics
For the Trade
QuantityDiscounts
Manufacturer (Coke) gives reseller (Price Chopper) a discount
f or purchasing large quantities of the manufacturers¶ pr oducts
Cash Discounts
Manufacturer (Coke) gives reseller (Price Chopper) a cash
discount f or paying their bill quickly
3/10 net 30: 3 percent cash discount if bill is paid in 10
days, otherwise the non-discounted bill is due in 30 days
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Step 6: Develop Pricing Tactics
For the Trade
Seasonal Discounts
Pr ovide resellers (Home Depot) price discounts f or buying pr oducts
off-season and either:
1. Storing the pr oduct at the resellers location until the right time
of year or,
2. Pass the discount along to the consumer with ³off-season sales´
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Pricing and E-Commerce
Dynamic Pricing
Cost of changing a price online is essentially zer o, hence
Online, sellers can adjust prices quickly (i.e., use dynamic pricing)
to meet changing needs in the marketplace
Used extensively with online auctions
Both types of sites adjust prices on the basis of supply and demand
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Pricing and E-Commerce
On-line Shoppers
Shopbots: offer price comparisons at a number of e-tailers
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Pricing and E-Commerce
Freenomics
http://www.wired.com/techbiz/it/magazine/16-03/ff_free?currentPage=all
Free: Why $0.00 is the future of Business
The more people you can get to participate in the marketplace, the
more pr ofitable the marketplace will be
How to get more people: Give things away f or free!
Radiohead music giveawayon MySpace
built a fan base
sold concert tickets sold merchandise
Ryanair: London to Barcelona, $20
a la carte f ood and beverage
fee f or preboarding fee f or checked baggage
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Psychological Issues in Setting Prices
Reference Prices
Internal reference price
expected price
price last paid
reser vation price
External reference price comparison price
what I expect to pay (j eans <$50)
what I paid last time (j eans = $45)
what is t he most I¶ m w illing to pay ($50)
standards the co
mpany tells yo
u
P rice listed on sales tag as ³ original´ price, whic h subsequent markdow ns have been made
Compare to competitor ¶ s price
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Psychological Issues in Setting Prices
Price-Perceived Quality Relationship
High-price equals high-quality Low-price equals low-quality
Research has f ound:
f or most pr oducts, consumers have both an upper- and a lower-price
threshold; if you go beyond either, demand will dr op
price-quality relationship holds mainly f or pr oducts whose quality
is difficult to assess
Experience goods ± you have to try the pr oduct bef ore you canassess its quality (e.g., hair cut, legal advice)
Credence goods ± even after you have purchased and used the pr oductquality is still hard to assess (e.g., vitamin supplements, car repair )
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Psychological Price Strategies
Research has f ound, increased sales occur with odd prices (US)
60% of prices in advertising material end in the digit 9
30% end in the digit 5
7% end in the digit 0
3% end in the remaining seven digits (1,2,3,4,6,7,8)
Does not hold f or all pr oducts/ser vices. In some cases, even is better
doctor¶s fees
luxury items (jewelry, resort accommodations)
lottery tickets
Odd-Even Pricing
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Deceptive Pricing
Bait and Switch
Illegal pricing scheme
Adv
ertise an item at av
ery lo
w price (bait) to
lure custo
mers to
sto
re,then switch them to a higher-priced item
Encouraging consumers to buy a higher-priced item is ok, but illegal
to advertise lower-priced time when it¶s not legitimate
Advertised Older model: $9000 Switch to newer model: $15000
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Unfair Pricing
Loss Leader Pricing
A loss leader may be placed in an inconvenient part of the store so that
consumers must walk past other goods which have higher profit margins
A loss leader is usually a product that customers purchase frequently.
thus they are aware of its usual price
Take a loss on a leader brand (e.g., Coke) to get customers to the store
Unfair because it hurts competition among smaller resellers, who
cannot compete on such low (leader) prices
Some characteristics of loss leaders:
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Illegal Business to Business Pricing
Price Discrimination
It is a violation of the Robinson-Patman Act (1936) f or manufacturers
to sell their pr oducts to similar retailers at different prices based solely
o
n thevo
lumeo
f pr o
ducts purchased.
Example:
In 1994, the American Booksellers Association (ABA; independent
booksellers) filed a federal complaint against Houghton Mifflin Company
and other book publishers ± alleging that the publishers violated theRobinson-Patman Act by offering price discounts to large national chains
(e.g., Borders, Barnes and Nobel)
ABA won and the publishers paid millions (~$25M) to ABA members.
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Illegal Business to Business Pricing
Price Fixing
Two or more companies conspire to keep prices at a certain (typicallyvery high) level, leading to increased pr ofits f or the companies
The companies involved in price fixing are sometimes referred to asa cartel.
Example:
November, 2008, US Justice Department f ound the 3 largest flat-screen
pr oducers ± LG of South Korea, Sharp of Japan, and Chunghwa of Taiwan ±
guilty of price fixing. The 3 companies pled guilty and agreed to pay
$585 million in criminal fines f or their r ole in fixing the price of liquid
crystal display panels. Payment will go to American companies affected
by the price-fixing (e.g., Dell, Apple, Motor ola)
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Illegal Business to Business Pricing
Predatory Pricing
Example:
Predatory pricing is the practice of selling a pr oduct or ser vice
at a very low price, intending to drive competitors out of the
market and create barriers to entry f or potential new competitors
In September, 2000, Wal-Mart was charged with predatory pricing in
Wisconsin, whereby the complaint alleged that Wal-Mart sold butter, milk,
laundry detergent, and other staple goods below cost in stores in Beloit,Oshkosh, Racine, Tomah, and West Bend in order to f orce other stores out
of business and gain a monopoly in these local markets.
The case was settled out of court with no fines