Choosing the right pricing strategy

Peter Ramsden

Paramount Learning Ltd

Outline

Importance of Price Factors affecting Price Pricing Strategies Price demand curves

What must I consider before setting price?

1. Know how much it costs to make and deliver product or service. Direct and Indirect costs. Fixed and Variable costs.

2. Know your breakeven point3. Research current prices in the

market.4. Consider your market

positioning and competitive advantage as this is likely to impact directly on your choice of pricing strategy.

Importance of Price

Choosing the right pricing strategy strengthens the chance of achieving turnover and profit in line with company objectives.

Importance of Price

Getting it wrong can be painful!

Importance of Price

First impressions Often price creates a first impression of the quality of the

product/service and other value based judgements come later.

Pricing low can signify cheap and cheerful, pricing high can indicate quality?

£5600

£65

Demand

Price

Typical Supply Demand Curve

Price Elasticity of Demand Elastic Demand –

Products are considered to exist in a market that exhibits elastic demand when a certain percentage change in price results in a larger and opposite percentage change in demand. 

For example, if the price of a product increases by 10%, the demand for the product is likely to decline by greater than 10%.

Inelastic Demand –

Products are considered to exist in an inelastic market when a certain percentage change in price results in a smaller and opposite percentage change in demand. 

For example, if the price of a product increases by 10%, the demand for the product is likely to decline by less than 10%. 

Elasticity of demand (PED) = % change in demand of good X / % change in price of good X If the PED is greater than one, the good is price elastic. Demand is responsive to a change in price.

If for example a 15% fall in price leads to a 30% increase in quantity demanded, the price elasticity = 2.

If the PED is less than one, the good is inelastic. Demand is not very responsive to changes in price. If for example a 20% increase in price leads to a 5% fall in quantity demanded, the price elasticity = 0.25

3% 13% 34% 34% 16%

Diffusion of Innovation

Laggards

Late followersMajority

Innovators

EarlyAdopters

Time

Number ofnew adopters

From EM Rogers, Diffusion of Innovation ( New York, The free press) 1995

Prices usually start high and decline as the product reaches maturity

Difficult to start prices low and subsequently increase prices later

The Elements of Cost

1. Direct Materials2. Direct Labour3. Direct Expenses

Prime or Product Cost1. Production Overhead

Production Cost1. Research and Development Cost2. Marketing and Distribution3. General Administration

Total Cost

(Used in the manufacture of the good or service)

Break Even Analysis

TIME

£

FIXED COSTS

VARIABLE COSTS

SALES1SALES2

Break Even Formulas

Profit = Sales – Expenditure Sales - variable costs = Contribution margin Contribution margin - Fixed Costs = Profit

Break even = Fixed Costs/Contribution per unit.

(Fixed cost + Required Profit)/Contribution per unit = units required to make profit.

Break Even Calcs

Break even = Fixed Costs

Contribution per unit

Item sold for £3000 with a variable cost of £1500 = Contribution of £1500

Fixed costs of £100,000 means that 66.6 units need to be sold at £3000 before the business breaks even.

Pricing Strategies

Market pricing Cost pricing

Mark up Margin generation Breakeven

Loss leader Psychological pricing

Prestige Odd even pricing

Demand

Competitive Pricing Below market Parity or Price Matching

Bundle Skimming Markdowns

Temporary Permanent

Payment and delivery terms

Market Pricing

Set prices at or around the middle of the market

Fight on other added value areas such as delivery, customer service etc

Price Range

Distribution Curve

£249 £399

O%

100%

Market pricing

Cost Plus Pricing

Cost Plus Pricing Cost of materials Cost of labour

Add an amount for profit

Does not take into account general overhead costs

Beware of making loss due to hidden overhead

Loss Leader

Pricing a product below cost to attract customers to higher margin products

Psychological Pricing

Prestige pricing Odd Even Pricing

Demand Pricing

Price varies based on some demand criteria

As your output increases/decreases your prices change.

Can confuse customers

Competitive Pricing

Matching or beating the market price

Bundle Pricing

Discounts offered to entice client to accept a bundle rather than one part only.

Example Product X £3,500 Product Y £4,500 Product Z £7,500 Total £15,500 Bundle Price £14,500

Discount of £1,000 or 6.5%

Skimming Pricing

Client insensitive to price. Works well in an inelastic

market. Client needs product. Little or no substitutes

available. Innovators, early adopters. Skim the cream off the top.

Markdowns

Temporary Finite life- Offer closes 31/10/08 Can be used to test the market

Permanent Often used to get rid of old stock or perishables

approaching end of shelf life Fire sale and soiled goods

Seasonal Fashions, clothing gardening etc

Payment and Delivery Terms

Considered part of the pricing mix. Cost for payment terms borne by supplier of

purchaser depending on terms agreed. Do not forget to take into account credit terms

and risk when pricing.

Pricing Decisions

Understand how much it costs to produce or procure a product/service.

Ensure that general overhead has been taken into account when setting pricing.

Research the typical market price for your product and service and pitch accordingly.

Understand your position in the market. High end value, cheap and cheerful or somewhere in

between. Set your price level, and review on going.