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Luiz Afonso dos Santos Senna - PhD
Pricing Strategies and Tactics
Luiz Afonso dos Santos Senna, PhD
Luiz Afonso dos Santos Senna - PhD
Fatores Externos afetando as decisões de preços
Mercado e demanda Custos definem o limite inferior e a demanda
define o limite de preço. As relações preço-demanda são fuindamentais
par aos teomadres de decisão em transportes
Fatores Externos incluem a natureza do mercado e da demanda, competição e outros elementos ambientais
Luiz Afonso dos Santos Senna - PhD
Preço em diferentes tipos de mercados
Mercados de Competição Pura Bens/serviços uniformes Não existe um único vendedor ou comprador com
efeito significativo sobre o preço de mercado Marketing mix possui pouco impacto
Luiz Afonso dos Santos Senna - PhD
Preço em diferentes tipos de mercados
Competição Monopolística Compradores e vendedores trocam sobre uma gama
de preços Ênfase em diferenças por meio de diferenciação
através de marketing mix Competição Oligopolística
Poucos vendedores altamente sensíveis aos preços de cada um e de estratégias de marketing
Luiz Afonso dos Santos Senna - PhD
Considerações primárias na fixação de preços
Objetivos de Pricing
Luiz Afonso dos Santos Senna - PhD
Cost-based versus value-based pricingSource: The Strategy and Tactics of Pricing, by Thomas T. Nagle and Reed K. Holden (2011)
Preço baseado em custos X baseado em valor
Luiz Afonso dos Santos Senna - PhD
How does our pricing strategy fit into this framework? What economic principles apply?
Porter’s Five Forces Model (old)
S u p p lie r P o w er
S u b stitu te s an d C o m p le m e n ts
In te rn a l R iva lry B u ye r P o w er
N e w E n tra n ts
Luiz Afonso dos Santos Senna - PhD
Market Structure – Internal rivalry
Market structure and pricing decisions are closely
related. But how to define the market?
The degree to which the firm gets to choose price is
determined in large part by market structure
There are two extreme cases: perfect competition
and monopoly
Luiz Afonso dos Santos Senna - PhD
Assessing and responding to a competitor’s price cut (depending on the market structure)
Luiz Afonso dos Santos Senna - PhD
Perfect Competition
Conditions necessary:
Large numbers of buyers and sellers
Homogeneous product
Free entry and exit
Perfect information
Luiz Afonso dos Santos Senna - PhD
Perfect Competition
Demand curve for any given firm is horizontal. Price is set by market at Pe
Firm can sell as much or as little as desired at market price, but nothing if they raise P.
Pe
S
D
DPe
Luiz Afonso dos Santos Senna - PhD
Monopoly
Conditions necessary Single seller of product No close substitutes Significant barriers to entry
There are few examples of perfect competition and pure monopoly.
Most firms have a differentiated product, and there are substitutes.
Luiz Afonso dos Santos Senna - PhD
Pricing in Perfect Competition
Do not choose price. Choose output quantity. TC includes opportunity
cost of capital invested. What will be our profit (loss) from our output
decision? Should we produce now? (SR) Should we stay in the industry? (LR)
Luiz Afonso dos Santos Senna - PhD
Costs at different levels of production
Cost per unit at different levels of production
Luiz Afonso dos Santos Senna - PhD
Pricing in a Monopoly
Profit maximization will be achieved by setting price so that MC=MR.
It is not reached by setting price as “high as possible.”
Like any firm, the monopolist is constrained by their demand curve.
One cannot choose both P and Q.
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule
At what point should the firm cease
production of a certain item?
When might it pay to produce at a loss?
In SR, many costs are fixed. Just because a
firm is making losses, it does not necessarily
mean it should shut down (short run), or even
go out of business (long-run).
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule cont.
Profit = TR – TC; TR=P*Q, TC = VC + FC
(TR - VC) - FC = [(P - AVC)Q] – FC
Separate out fixed costs, focus on variable elements
As long as P>AVC, there is a positive contribution to fixed
costs.
If firm shuts down (Q = 0), then Profit = - FC
If shut down: Firm has a loss of fixed costs.
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule cont.
In SR, firm may minimize losses by continuing to
produce.
If losses are expected permanently, get out.
Case of multiple products:
C = FC + VC1 + VC2
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule
1. = (TR1 - TVC1) + (TR2 - TVC2) - FC
2. = (P1*Q1 - AVC1*Q1) + (P2*Q2 - AVC2*Q2) - FC
3. = [(P1 - AVC1)*Q1]+ [(P2 - AVC2)*Q2] - FC
Results:
1. SR - each product should be produced if Pi>AVCi
2. In LR, the firm should continue operating only if expected 0 (Profits are non-negative)
Luiz Afonso dos Santos Senna - PhD
Price Discrimination
Selling the same good to different people at different prices
Conditions necessary: Identifiable customer groups with differing price
elasticities Maintain separation of groups--prevent resale.
Luiz Afonso dos Santos Senna - PhD
Types of Price Discrimination First degree
Identify and charge each customer what they are willing to pay
Limit: D = MR, no consumer surplus. Second degree
Quantity discounts. Volume purchases are given lower prices. Need to measure goods and services bought by consumers.
Luiz Afonso dos Santos Senna - PhD
Types of Price Discrimination
Third degreeSegment markets in some way. Charge
all in the segment the same prices. Treat each segment as a separate
market– then do MR=MC in eachAre coupons as a price discrimination
mechanism?
Luiz Afonso dos Santos Senna - PhD
Oligopoly Strategies
Common theme - Rivalrous behavior Pricing - limit pricing - set prices low as signal
to possible entrants or other competitors your willingness and ability to defend your market share.
Must have credibility.Trading SR profit for more profits later
Luiz Afonso dos Santos Senna - PhD
Oligopoly Strategies
Use the legal / regulatory systems
File patent application
Challenge business charter application
File regulatory challenge
Pre-emptive entry - Wal-Mart
Luiz Afonso dos Santos Senna - PhD
Oligopoly Strategies
Capacity and production
Announce capacity expansion
Revise/modify products - more
difficult to copy Advertising
Raise cost of entry for others
Luiz Afonso dos Santos Senna - PhD
Oligopoly and Monopolistic Competition Oligopoly
Few sellers - usually large onesRecognized interdependence in
pricing and output decisionsNeed to consider response of rivals in
pricing decisionsTypically significant barriers to entry
Luiz Afonso dos Santos Senna - PhD
Oligopoly and Monopolistic Competition
Monopolistic Competition
Large number of interdependent
sellers
Differentiated product
Good substitutes
Easy entry and exit
Luiz Afonso dos Santos Senna - PhD
Oligopoly and Monopolistic Competition Most industries are one or the other
Oligopoly: many heavy manufacturing Autos, steel, chemicals, pharmaceuticals
Monopolistic Competition Service companies, retail stores, large
corporations (McDonald’s, Wendy’s) The important point is that demand is downward
sloping
Luiz Afonso dos Santos Senna - PhD
Cartels
Illegal in most countries – but encouraged in others
Conditions helpful:Small number of firmsHomogeneous productEntry barriersSimilarity of members
Luiz Afonso dos Santos Senna - PhD
Cartels
Problems with cartels:
Cheating on agreementPrice cutting behaviourTend to fall apart
Note: When might firms in an industry ask for (demand) regulation?
Luiz Afonso dos Santos Senna - PhD
Pricing Strategies
Profit maximizing rule: Set production at level where MR = MC
Non - Maximizing pricing rules there are a variety of these
Luiz Afonso dos Santos Senna - PhD
Pricing for Multi-Product Firm
Two products, x and y. TRfirm = TRx + TRy
If there are any spillovers from x to y, then you may get complications.
MR =TR
Q
TR
Q
TR
Qx
x
x
x
y
x
d
d
d
d
d
d
MR =TR
Q
TR
Q
TR
Qy
y
y
y
x
y
d
d
d
d
d
d
Luiz Afonso dos Santos Senna - PhD
Multi-Product Firm cont.
The two terms on the right side of the equation represent interactions. They can be either positive or negative.
If x and y are complementary goods, the effect is positive.
If x and y are substitutes, the effect is negative. One unit’s gain is the other’s loss.
Luiz Afonso dos Santos Senna - PhD
Two part pricing Charge P = MC charge a fixed fee to extract some of the
“consumer surplus” Examples:
country clubs health clubs electricity providers
Luiz Afonso dos Santos Senna - PhD
Declining block pricing
Charging different prices according to how much is purchased
Attempt to extract consumer surplus and transfer value to company
Luiz Afonso dos Santos Senna - PhD
Auction pricing models Standard auction model
multiple bidders compete with each other start at some low price, then successive bids
raise price until someone “wins”
Dutch auction model start at a high price, lower it until someone bids ex: dutch flower auctions
How to extract consumer surplus?
Luiz Afonso dos Santos Senna - PhD
How does the development of online business affect this analytic tool? How does the Internet change the economic principles that apply?
Porter’s Five Forces Model
S u p p lie r P o w er
S u b stitu te s an d C o m p le m e n ts
In te rn a l R iva lry B u ye r P o w er
N e w E n tra n ts
Luiz Afonso dos Santos Senna - PhD
Market structure and the Internet
Traditional industry structure paradigm? Structure, time and place? Firm size, customer access and service? Pricing, and reputation online Who is competing with whom?
Luiz Afonso dos Santos Senna - PhD
Internet and demand issues
Role of customer service and customer loyalty online: e-loyalty?
Consumer demand issues - which goods to buy online, which in person?
How to price online? Does this signal the end of the Brand?
Luiz Afonso dos Santos Senna - PhD
Pricing and the Internet
Traditional pricing paradigm? Access to demand data…... Measurement of demand elasticities? Ability to conduct pricing “experiments” Ability to spot market changes - and
move quickly (perhaps) Access to bigger customer base Will prices be lower online?
Luiz Afonso dos Santos Senna - PhD
Firm structure and the Internet Are traditional firm structure concepts now
irrelevant? Economies of scale? Scope? How does this affect firm incentives to
vertically integrate (or de-integrate)? Central role of transaction costs…...
Luiz Afonso dos Santos Senna - PhD
The Determinants of Demand
Demand The relationship between the quantity of a good desired by people in a market and the factors that affect that the quantity desired is referred to as the demand for the product. We can express the demand for a product in the form
We have some precise definitions related to how income and prices of other goods affect the demand for a good/service
Luiz Afonso dos Santos Senna - PhD
Factors that we expect to affect the demand for the good include:
Population (n) Price of the good (pi) Price of other goods (pj) Income (y) Expectations of future prices Tastes (T)
Luiz Afonso dos Santos Senna - PhD
Substitutes and Complements
Two goods, x and y, are said to be substitutes if an increase in the price of x (y) increases the demand for good y (x) and a decrease in the price of x (y) decreases the demand for y (x) – (Butter and margarine)
Two goods, x and y, are said to be complements if an increase in the price of x (y) decreases the demand for good y (x) and a decrease in the price of x (y) decreases the demand for y (x) (Sugar and coffee)
Luiz Afonso dos Santos Senna - PhD
Income and Demand
A good is said to be normal if an increase (decrease) in income increases (decreases) the demand for the good. A good is said to be inferior if an increase (decrease) in income decreases (increases) the demand for a good
Luiz Afonso dos Santos Senna - PhD
The Demand Curve
The relationship between the quantity demanded of a good and the price of that good is referred to
as the demand curve.
Luiz Afonso dos Santos Senna - PhD
Figure 5
0
1
2
3
4
5
6
7
8
9
10
0 10 20 30 40 50 60 70 80 90 100
Quantity
Pri
ce (
$)
D
Luiz Afonso dos Santos Senna - PhD
The demand curve gives the relationship between price and the quantity consumers will desire to purchase at that price
Note the demand curve is drawn given that no other factors affecting the demand for the product, such as income, population, or tastes, change
Demand for the product is based on specific, unchanging values for the other factors that affect demand
Luiz Afonso dos Santos Senna - PhD
As the price of a good decreases (increases), more (less) of it will be purchased
That is, the demand curve is downward sloping There are two factors that explain this
relationship: As the price of a good increases, consumers will substitute into
other goods (substitution effect); .As the price of a good increases, consumers will have less real
income to purchase all goods (income effect).
The Law of Demand
Luiz Afonso dos Santos Senna - PhD
Changes in Demand versus Changes in Quantity Demanded
A movement along a demand curve is referred to as a change in quantity demanded. The quantity demanded changes because of a price
change. A shift in the demand curve is referred to as a change in
demand. Demand changes (the demand curve shifts) because of a
change in one of the factors affecting demand other than price (income, price of other goods, tastes, population) changes.
Luiz Afonso dos Santos Senna - PhD
Demand for steaks D1 represents the demand for steaks (lbs/day) given the
price of chicken is $3.50; the number of customers is 1,500 a day; and the average annual household income is $40 thousand.
Then we might expect the following: A decrease in demand for steak if the price of chicken, a
substitute for steak, fell from $3.50 to $2.00. This is shown by a shift in of the demand curve from D1 to D2
An increase in demand for steak if the annual income increases from $40 to $60 thousand, since steak is a normal good. This is shown by a shift out of the demand curve from D1 to D3
Luiz Afonso dos Santos Senna - PhD
Figure 1
0
1
2
3
4
5
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7
8
9
10
0 10 20 30 40 50 60 70 80 90 100
Quantity
Pri
ce (
$)
D
Luiz Afonso dos Santos Senna - PhD
0
1
2
3
4
5
6
0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000
Pri
ce ($
/lb
)
Quantity (lbs of Steak/Day)
D1
D2
D3
D4
Luiz Afonso dos Santos Senna - PhD
Algebraic Representation
The preceding figure that follows is given by
QD = 100 - 10P
Linear relationship we can graph by choosing two points. Easiest points: Q = 0 0 = 100 - 10P or P = 10, Q = 0 P = 0 implying Q = 100 - 10(0) = 100 and
therefore P = 0, Q = 100 Slope, dQ/dP = -10
Luiz Afonso dos Santos Senna - PhD
The Determinants of Supply
Number of Firms Price of Product Cost of inputs
Wages Capital Materials
Price of other goods Expectations of Future Prices Technology
Luiz Afonso dos Santos Senna - PhD
The Supply Curve
The relationship between the quantity supplied of a good and the price of that good is referred to as the supply curve The supply curve gives the relationship between
price and the quantity produces will wish to sell at that price
Note the supply curve is drawn given that no other factors affecting the supply for the product Supply of the product is based on specific,
unchanging values for the other factors that affect supply
Luiz Afonso dos Santos Senna - PhD
Figure 3
0
2
4
6
8
10
12
14
16
0 10 20 30 40 50 60 70 80 90 100
Q
$
S
Luiz Afonso dos Santos Senna - PhD
The Law of Supply
As the price of a good increases (decreases), more (less) of it will be produced and offered for sale. The supply curve is upward sloping.
This is explained by the assumption that marginal (incremental) cost increases as output increases.
Luiz Afonso dos Santos Senna - PhD
Changes in Supply versus Changes in Quantity Supplied
A movement along a supply curve is referred to as a change in quantity supplied. The quantity supplied changes because
of a price change. A shift in the supply curve is referred to
as a change in supply. Supply changes (the supply curve shifts)
because of a change in one of the factors affecting supply other than price changes.
Luiz Afonso dos Santos Senna - PhD
Comparisons
What happens to Price & Quantity when: Incomes increase Wages fall Prices of other goods change
Making predictions of the impact on the market of these types of changes is referred to as Comparative Statics
Luiz Afonso dos Santos Senna - PhD
Comparisons
These changes are all changes in demand or changes in supply Shifts in demand or supply curve
4 possibilities: Increase in demand (shift out demand curve) Decrease in demand (shift in demand curve) Increase in supply (shift out supply curve) Decrease in supply (shift in supply curve)
Luiz Afonso dos Santos Senna - PhD
The Impact of Market Condition Changes on Equilibrium Price and Quantity
Market Change
Impact on Equilibrium
Price
Impact on Equilibrium
Quantity
Examples
Increase in Demand
+ + Increase in Income (normal good); increase in price of substitute; decrease in price of complements; increase in population
Decrease in Demand
- - Opposite of increase in demand
Increase in Supply
- + Technological innovation; increase in suppliers; decreases in costs
Decrease in Supply
+ - Increase in costs or wages; increase in price of alternative product produced by firms
Luiz Afonso dos Santos Senna - PhD
Pricing Strategy
How does a company decide what price to charge for its products and services?
What is “the price” anyway? doesn’t price vary across situations and over time?
Some firms have to decide what to charge different customers and in different situations
They must decide whether discounts are to be offered, to whom, when, and for what reason
Luiz Afonso dos Santos Senna - PhD
Why is Pricing Important?
In a company with average economics*, 1% increase in volume = 3.3% increase in
profit 1% increase in price = 11.1% increase in
profit Improvements in price typically have 3-4
times the effect on profit as proportionate increases in volume.
*Based on average of 2,463 companies
Luiz Afonso dos Santos Senna - PhD
Price vs. Nonprice Competition
In price competitionprice competition,, a seller regularly offers products priced as low as possible and accompanied by a minimum of services
In non price competitionnon price competition, a seller has stable prices and stresses other aspects of marketing
With value pricingvalue pricing, firms strive for more benefits at lower costs to consumer
With relationship pricing,relationship pricing, customers have incentives to be loyal-- get price incentive if you do more business with one firm
Luiz Afonso dos Santos Senna - PhD
Nonprice Competition
Some firms feel price is the main competitive tool, that customers always want low prices
Other firms are looking for ways to add value, thereby being able to avoid low prices
Sometimes prices have to be changed in response to competitive actions
Many firms would prefer to engage in non non price competitionprice competition by building brand equity and relationships with customers
Luiz Afonso dos Santos Senna - PhD
SELECT PRICING OBJECTIVE
SELECT METHOD OF DETERMINING THE BASE PRICE:
Cost-pluspricing
Price based onboth demandand costs
Price set inrelation tomarket alone
DESIGN APPROPRIATE STRATEGIES:
Price vs. nonprice competitionSkimming vs. penetrationDiscounts and allowances
Freight paymentsOne price vs. flexible pricePsychological pricing
Leader pricingEveryday low vs. high-low pricingResale price maintenance
The Process: An Illustration
Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Establish Pricing Objectives Increase sales
volume? Prestigious image? Increase market
share?
Luiz Afonso dos Santos Senna - PhD
Steps for Determining PricesStudy CostsStudy Costs
Can you make a profit?
Can you reduce costs without affecting quality or image?
Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Estimate Demand What do customers
expect to pay? Prices usually are directly
related to demand.
Luiz Afonso dos Santos Senna - PhD
Steps for Determining PricesDecide on a
Pricing Strategy Price higher than the
competition because your product is superior
Price lower, then raise it once your product is accepted
Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Set PriceMonitor and evaluate its effectiveness
as conditions in the market change
Luiz Afonso dos Santos Senna - PhD
Pricing Technology Smart Pricing – decisions are based on an
enormous amount of data that Web-based pricing technology crunches into timely, usable information.
Communicating Prices to Customers – electronic gadgets that provide real-time pricing information such as electronic shelves, digital price labels
Luiz Afonso dos Santos Senna - PhD
Pricing Technology
RFID Technology – wireless technology that involves tiny chips imbedded in products. The chip has an antenna, a battery, and a memory chip filled with a description of the item
Toll technology
Luiz Afonso dos Santos Senna - PhD
Geographic Considerations Geographic Considerations FOB (free on board) plant or FOB originFOB (free on board) plant or FOB origin:
Price quotation that does not include shipping charges. Buyer pays all freight charges to transport the product from the manufacturer
Freight absorptionFreight absorption: system for handling transportation costs under which the buyer may deduct shipping expenses from the costs of goods
Geographic ConsiderationsGeographic Considerations
Luiz Afonso dos Santos Senna - PhD
Uniform-delivered priceUniform-delivered price: system for handling transportation costs under which all buyers are quoted with the same price, including transportation expenses
Zone pricingZone pricing: system for handling transportation costs under which the market is divided into geographic regions and a different price is set in each region
Basing-point systemBasing-point system: system for handling transportation costs in which the buyer’s costs included the factory price plus freight charges from the basing-point city nearest the buyer. Seeks to equalize competition between distant marketers
Luiz Afonso dos Santos Senna - PhD
Types Types of Productsof Products
StagesStagesof Productsof Products
Product CharacteristicsProduct Characteristics
Luiz Afonso dos Santos Senna - PhD
Other Pricing StrategiesOther Pricing Strategies
Price-BasedPrice-Based
OptimizationOptimization
SkimmingSkimming
PenetrationPenetration
Luiz Afonso dos Santos Senna - PhD
Price Adjustment StrategiesPrice Adjustment Strategies
Discount PricingDiscount Pricing
BundlingBundling
Dynamic PricingDynamic Pricing
Luiz Afonso dos Santos Senna - PhD
Penetration Pricing
Price set to ‘penetrate the market’
‘Low’ price to secure high volumes
Typical in mass market products – chocolate bars, food stuffs, household goods, etc.
Suitable for products with long anticipated life cycles May be useful if launching into a new market
Luiz Afonso dos Santos Senna - PhD
Market Skimming High price, Low volumes
Skim the profit from the market
Suitable for products that have short life cycles or which will face competition at some point in the future (e.g. after a patent runs out)
Examples include: Playstation, jewellery, digital technology, new DVDs, etc.
Luiz Afonso dos Santos Senna - PhD
Market Skimming
Many are predicting a firesale in laptops as supply exceeds demand
Plasma screens: Currently athigh prices but for how long?
Title: Thin-shaped television. Copyright: Getty Images, available from Education Image Gallery
Luiz Afonso dos Santos Senna - PhD
Value Pricing
Price set in accordance with customer perceptions about the value of the product / service
Examples include status products/exclusive products
Companies may be able to set prices according to perceived value.
Title: BMW At The Frankfurt Auto Show. Copyright: Getty Images, available from Education Image Gallery
Luiz Afonso dos Santos Senna - PhD
Loss Leader
Goods/services deliberately sold below cost to encourage sales elsewhere
Typical in supermarkets, e.g. at Christmas, selling bottles of gin at £3 in the hope that people will be attracted to the store and buy other things
Purchases of other items more than covers ‘loss’ on item sold
e.g. ‘Free’ mobile phone when taking on contract package
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Used to play on consumer perceptions
Classic example - $9.99 instead of $10.00!
Odd-even: $5.95, $.79, $699 OR $12, $50
Multiple Unit-3 for !1.00 better than $.34 each
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Odd-Even PricingOdd numbers convey a bargain
image -- $.79, $9.99, $699
Even numbers convey a quality image -- $10, $50, $100
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Prestige Pricing – sets a higher than
average price to suggest status
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Multiple-Unit Pricing – 3 for $.99Suggests a bargain and helps
increase sales volume.Better than selling the same items
at $.33 each.
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Everyday Low Prices (EDLP) – set on a consistent basis
Luiz Afonso dos Santos Senna - PhD
Going Rate (Price Leadership)
In case of price leader, rivals have difficulty in competing on price – too high and they lose market share, too low and the price leader would match price and force smaller rival out of market
May follow pricing leads of rivals especially where those rivals have a clear dominance of market shar
Where competition is limited, ‘going rate’ pricing may be applicable – banks, petrol, supermarkets, electrical goods – find very similar prices in all outlets
Luiz Afonso dos Santos Senna - PhD
Tender Pricing
Many contracts awarded on a tender basis
Firm (or firms) submit their price for carrying out the work
Purchaser then chooses which represents best value
Most government contractsA European consortium led by Airbus recently won a contract to supply refuelling services to the RAF – priced at £13 billion!
Luiz Afonso dos Santos Senna - PhD
Price Discrimination
Charging a different price for the same good/service in different markets
Requires each market to be impenetrable
Requires different price elasticity of demand in each market
Air/rail First class Business class Economy class
Prices for rail travel differ for the same journey at different times of the day
Luiz Afonso dos Santos Senna - PhD
Discounts and Allowances
Cash Discounts – offered to buyers to encourage them to pay their bills quickly.2/10, net 30
Quantity Discounts – offered for placing large orders
Trade Discounts – the way manufacturers quote prices to wholesalers and retailers.
Luiz Afonso dos Santos Senna - PhD
Promotional Pricing -- Used with sales promotion Loss Leader Pricing – offering very
popular items for sale at below-cost prices
Special-EventBack-to-school specialsDollar daysAnniversary sales
Rebates and Coupons
Luiz Afonso dos Santos Senna - PhD
Discounts and Allowances
Seasonal Discount – offered outside the customary buying season
Luiz Afonso dos Santos Senna - PhD
Discounts and Allowances
Allowances – go directly to the buyer. Customers are offered a price reduction if they sell back an old model of the product they are purchasing
Luiz Afonso dos Santos Senna - PhD
Destroyer/Predatory Pricing
Deliberate price cutting or offer of ‘free gifts/products’ to force rivals (normally smaller and weaker) out of business or prevent new entrants
Anti-competitive and illegal if it can be proved
Typical of oligopoly with collusionMicrosoft – have been accused of predatory
pricing strategies in offering ‘free’ software as part of their operating system – Internet Explorer and Windows Media Player - forcing competitors like Netscape and Real Player out of the market
Luiz Afonso dos Santos Senna - PhD
114
The Legality and Ethics ofPrice Strategy
Issues Issues That LimitThat LimitPricing Pricing DecisionsDecisions
Issues Issues That LimitThat LimitPricing Pricing DecisionsDecisions
Unfair Trade PracticesUnfair Trade Practices
Price FixingPrice Fixing
Price DiscriminationPrice Discrimination
Predatory PricingPredatory Pricing
Luiz Afonso dos Santos Senna - PhD
Unfair Trade Practice Acts
Laws that prohibit wholesalers
and retailers from selling
below cost
Luiz Afonso dos Santos Senna - PhD
Price Fixing
An agreement between two or
more firms on the
price they will charge
for a product (usually in oligopolistic
markets)
Luiz Afonso dos Santos Senna - PhD
Price Discrimination
The Robinson-Patman Act of 1936 (USA):
Prohibits any firm from selling to two or more different buyers at different prices if the result would lessen competition
Luiz Afonso dos Santos Senna - PhD
118
Robinson-Patman Act Defenses
Seller Defenses Seller Defenses Seller Defenses Seller Defenses
CostCost MarketConditions
MarketConditions CompetitionCompetition
Luiz Afonso dos Santos Senna - PhD
Predatory Pricing
The practice of charging a
very low price for a product
with the intent of driving
competitors out of business or
out of a market.
Luiz Afonso dos Santos Senna - PhD
120
Discussion: Impact of Ethics on Pricing How should you price if your product is a life-
saving drug? What are the ethical considerations?
Customers have no choice Need to pay for the research When cheaper options doesn’t work Competition decides
Luiz Afonso dos Santos Senna - PhD
Some other pricing strategies
These all involve the use of some numerical understanding….
Luiz Afonso dos Santos Senna - PhD
Absorption/Full Cost Pricing
Full Cost Pricing – attempting to set price to cover both fixed and variable costs
Absorption Cost Pricing – Price set to ‘absorb’ some of the fixed costs of production
Luiz Afonso dos Santos Senna - PhD
Marginal Cost Pricing
Marginal cost – the cost of producing ONE extra or ONE fewer item of production
MC pricing – allows flexibility Particularly relevant in transport where fixed costs may be
relatively high
Allows variable pricing structure – e.g. on a flight from London to New York – providing the cost of the extra passenger is covered, the price could be varied a good deal to attract customers and fill the aircraft
Luiz Afonso dos Santos Senna - PhD
Marginal Cost Pricing
Example:
Aircraft flying from Bristol to Edinburgh – Total Cost (including normal profit) = £15,000 of which £13,000 is fixed cost*
Number of seats = 160, average price = £93.75
MC of each passenger = 2000/160 = £12.50
If flight not full, better to offer passengers chance of flying at £12.50 and fill the seat than not fill it at all! *All figures are estimates only
Luiz Afonso dos Santos Senna - PhD
Contribution Pricing
Contribution = Selling Price – Variable (direct costs)
Prices set to ensure coverage of variable costs and a ‘contribution’ to the fixed costs
Similar in principle to marginal cost pricing Break-even analysis might be useful in such
circumstances
Luiz Afonso dos Santos Senna - PhD
Target Pricing
Setting price to ‘target’ a specified profit level Estimates of the cost and potential revenue at
different prices, and thus the break-even have to be made, to determine the mark-up
Mark-up = Profit/Cost x 100
This strategy is used by many clothes retailers where they can add upto 60% mark-up on the basic cost of the clothes. So even with a 50% sales offer they still make a profit!
Luiz Afonso dos Santos Senna - PhD
Cost-Plus Pricing
Calculation of the average cost (AC) plus a mark up
AC = Total Cost/Output
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Influence of Elasticity
Price Inelastic: % change in Q < % change in P
e.g. a 5% increase in price would be met by a fall in sales of something less than 5%
Revenue would rise
A 7% reduction in price would lead to a rise in sales of something less than 7%
Revenue would fall
Luiz Afonso dos Santos Senna - PhD
Influence of Elasticity
Any pricing decision must be mindful of the impact of price elasticity
The degree of price elasticity impacts on the level of sales and hence revenue
Elasticity focuses on proportionate (percentage) changes
PED = % Change in Quantity demanded
% Change in Price
Luiz Afonso dos Santos Senna - PhD
Influence of Elasticity
Price Elastic: % change in quantity demanded > % change in price
e.g. A 4% rise in price would lead to sales falling by something more than 4%
Revenue would fall
A 9% fall in price would lead to a rise in sales of something more than 9%
Revenue would rise
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137
Select a Pricing Method
Mark-up Pricing - “Cost Plus” Target Return Pricing Perceived Value Pricing
Luiz Afonso dos Santos Senna - PhD
Device Pricing vs. Whole Product Pricing
Value of any product to its market is strongly influenced by prices of competitive products
Competitive “devices” are analyzed, but “products” are priced
Product “features” have different values: Customer service Warranties Distribution channels (e.g., convenience)
The “sum” of the features makes up the “product”
Luiz Afonso dos Santos Senna - PhD
Determining Perceived Value
What value is placed on the end result? The cost of alternative solutions to the customer. A function of:
Prices of comparable (though not identical) products
The “value” (+/-) of the product’s differences vs. the competitive offering
The value of the “Whole Product”
Luiz Afonso dos Santos Senna - PhD
Economic Value Analysis
Identify the cost of the competitive product or process (i.e., the reference value)
Identify all the factors that differentiate the product.
Determine the value to the customer of these differentiating factors (i.e., the differentiation value)
Sum the reference value and the differentiation value to determine the total economic value.
Luiz Afonso dos Santos Senna - PhD
Product Performance
Economic Value
Customer’s Perceived
Value
Marketing Effort*
Pricing Decision
*A key task of marketing is to translate
the economic value into high customer perceived value
Economic Value vs. Perceived Value
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Select a Pricing Method
Mark-up Pricing - “Cost Plus” Target Return Pricing Perceived Value Pricing Value Pricing Going Rate Pricing (market price) Reference Pricing (comparison w/substitutes) Sealed-Bid Pricing
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Select the Final Price
Desired/Required Distributor Margins Psychological pricing Influence of other marketing mix elements Company pricing policies Impact of price on others
$2,000,000$ 10,000
$ 375.00
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Conjoint AnalysisStated Preference Methods
Trade-off Analysisand
Behavioural models
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Behavioural Models -Logit Model-
e= basis of the logarithm neperianoi- alternative being consideredJ= set of alternatives where i is one of themUi= utility function of altarnative iUj= utility function of alternative j
Luiz Afonso dos Santos Senna - PhD
Data Collection
Revealed Preference Data gained from experience Good to know about previous experience and
existing products/services Stated preference
Data gainded from hipothetical questions in selected scenarios
Good to gain information about new services/products