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Lecture 1 Overview of Pricing Strategies & Psychological Aspects of Pricing I
Price & Profitability Price is the value that customers give up or
exchange to obtain a desired product. Payment may be in the form of:
money, service or goods (bartering), favors, votes, or anything else of value to the other party.
Profitability Profit = Total Revenue – Total Costs (Unit Price x Quantity Sold) – Total Costs
Pricing Strategies Pricing – is about designing the right price for the right customer at the
right time and location. Strategies – are systematic plans that takes many relevant factors into
consideration. Profit maximization Unit sales maximization Gaining market share Discouraging market entry by competitors
Good pricing strategies are usually… #1 Based on a solid understanding of the three C’s #2 Customized #3 Identified by trial-and-error
Mini-case study
#1 Pricing strategy is based on a solid understanding of the three C’s
Cost?
Customers?
Competition?
Mini-case study
#2 Pricing strategy is customized
The company customizes the pricing of its sales lead according to the following:
Type of leads received Quality of leads received Number of contractors it sells to Identity of buyers
Mini-case study
#3 Current pricing strategy is identified by trial-and-error
Why is pricing strategy important? – A Hypothetical Example
Price $100
Old New
Profit Driver
Old New
Profit PercentageIncrease in
Profit
Considera 10%
improvementin…
Source: Dolan, R.J. and H. Simon (1996), Power Pricing: How Managing Price Transforms the Bottom Line, New York: Free Press, 369 p.
Variable Cost $60
Sales Volume 1 mil
Fixed Costs $30 mil
When does an increase in price have a greater boost on bottom-line / margin?
Current margin - high
Current margin - low
High Fixed Cost
Low Fixed Cost
Sales Volume - High
Sales Volume - Low
Percentage Change on Margin
Percent change in bottom-line
Why is pricing strategy important? – More real-life examples
Company Percentage increase in net income if the price is up by 1% and without the negative impact on demand
Coca-Cola
Fuji Photo
Nestle
Ford Motor Company
A typical large U.S. Corporation
A price increase of less than 1 cent on a can of cola would translate into more than 300 million dollars of net income
6.4%
16.7%
17.5%
26%
12%
Psychological Aspects of Pricing
Transaction Utility Perception Bias Weber-Fechner Law Status Quo Bias
PricePrice
Transaction Utility
Price consumeris willing to pay
Economic Value For the consumer
TransactionUtility
$0
Implications for Transaction Utility
Perceived fairness of transaction matters as much as monetary cost.
Many “irrational behavior” can be explained by transaction utility.
Consumer perception of a price change depends on the percentage, not the absolute difference, and there are thresholds above and below a product’s price at which price changes are noticed or ignored.
Perception Bias
It’s not easy to be penny-wise
Perception of Price Differences
Perception of Odd Ending Prices
Odd ending prices: $.99 $1.99 $9.89 $199.99
The odd-price states that consumers process prices by reading numbers from left to right rather than by calculating an absolute change in price.
Researchers yet to find conclusive evidence has revealed that odd-pricing effect actually exists, although data for grocery items do seem to indicate that there is an odd-price sales effect.
For an odd-pricing scheme to work, the item must be purchased with a relatively high frequency and be a relatively inexpensive item. Otherwise, consumers would make time to more closely examine the price.
Implication of Perception Bias
Baseline Price
Threshold Price
Price IncreasePrice Increase
Implication of Perception Bias
Baseline Price
Threshold Price
Price DecreasePrice Decrease
Implication of Perception Bias
Which price statement might be better?
$245 a year
$.67 a day
Weber-Fechner Law
You set off to buy a Sony Walkman at what you believe to be the cheapest store in the area. Upon arriving, you find that the Walkman you want costs $29, a price consistent with your prior expectations. As you are about to make the purchase, a reliable friend tells you that the very same Walkman is selling for $10 less at a store approximately 10 minutes away. Do you go to the other store to buy the Walkman?
Scenario #1
Weber-Fechner Law
You set off to buy a Sony Camcorder at what you believe to be the cheapest store in the area. Upon arriving, you find that the Walkman you want costs $495, a price consistent with your prior expectations. As you are about to make the purchase, a reliable friend tells you that the very same Walkman is selling for $10 less at a store approximately 10 minutes away. Do you go to the other store to buy the Walkman?
Scenario #2
New Car Purchase with Trade-In
Dealers of new cars usually give you the opportunity of trading in your old one
Why is it not a good idea to trade in?
A common wisdom of buying a new car is that whenever possible, do not trade in your old car with the same dealer.
Why? Think about a $500 difference:
it means: 2.5% of the price of your new car
or
25% of the price of your trade-in car.
A “full rationality” point of view says it is the absolute monetary instead of the percentage of price that should be calculated.
However, consumers tend to evaluate differences in quantities relative to the level of a baseline quantity
The Weber-Fechner Law, when applied to pricing, suggests that consumers tend to evaluate prices on proportional terms rather than in absolute terms (absolute magnitude).
Price differences seem less important as base price increases
Which one is easier to get noticed:
$ 0.50 price increase for the bottled water or
a $2.00 price increase for your textbook.
Weber-Fechner Law
Implications of Weber-Fechner Law
In the car trade-in example and similar scenarios, understand “which battle is more worthwhile fighting”.
Traffic-generating price discount should be given to low-value SKUs.
Status-quo Bias
Should you switch the door or not?
Player picks Host revealsThird door contains
Goat A Goat B Car
Goat B Goat A Car
Car Goat A or Goat B Goat B or Goat A
Experiment on Status Quo Bias
Same mug, two different experiment groups. Selling price vs. buying price. Participants who “owned” the mug place a
greater value on it.
Implication for Status-quo Bias
Free-trial can work well if it can induces status-quo bias.
Again, be aware if you HAVE TO buy a new car and trade in your old car at the same time!
Summary
Why might you make a decision that doesn’t make economic sense?
Why do you see so many price tags ending with nines
in various retail outlet (Supermarket, convenience store, etc)?
Why is it not a good idea to trade in your old car when you are buying a new car?
Why do companies offer free-trial offers?
Transaction utility
Perception bias
Weber-Fechner Law
Status-quo bias
Next Lecture
More on Behavioral Aspects of pricing strategies