PRICING

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The Meaning of Price

Price =

1. Value

2. Cost

3. Sacrifices

4. Utility

Some important pricing definitions

Utility: The attribute that makes it capable of want satisfaction

Value: The worth in terms of other products

Price: The monetary medium of exchange.

Value Example: CaterpillarTractor is $100,000 vs.

Market $90,000$90,000 if equal 7,000 extra durable 6,000 reliability 5,000 service 2,000 warranty $110,000 in benefits -

$10,000 discount!

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The Customer Wants Value

price is not always an important factor in influencing a sale; the customer wants more than a low price, may be willing to pay more

the customer considers what he or she gets for the price paid; the seller must offer value

price of a product or service communicates a message to the consumer about quality

what causes them to conclude that they “paid too much” or “got a great deal”?

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The Consumer’s View of Price

some consumers are very interested in getting a low price and pay close attention to price; they are price sensitive. But, this is variable and personal

many are interested in other elements of the purchase, including brand, quality, etc.

there is a tendency to link quality with price

consumers are often prepared to pay more if they expect to get added value

adding value doesn’t mean dropping price

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Factors Affecting Price

Price

cost

elasticity

Product characteri

stic

Marketing mix

Competition

Goal/ objective

s

Setting Pricing Policy

1. Selecting the pricingobjective

2. Determining demand

3. Estimating costs

4. Analyzing competitors’costs, prices, and offers

5. Selecting a pricingmethod

6. Selecting final price

Setting Pricing Policy

1. Selecting the pricingobjective

SurvivalMaximum current profitMaximum market shareMaximum market skimmingProduct-quality leadership

2. Determining demand

the cost of producing or offering the product or service must be considered in setting price

while easy to calculate, cost-plus pricing is not usually practical and is not often used

occasionally, a firm will sell below cost

occasionally also, a firm will price so as to recover marginal (variable) costs only

when would such approaches be used?

3. Estimating costs

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Costs and Break-Even Analysis

cost is viewed as a floor under a firm’s price

many firms do not have particularly good cost data and may not know what it costs to produce a product or service

the break-even point is where total revenue equals total costs; will be different for each price -- lets a firm see what it will need to sell

break-even analysis is not a pricing strategy, but can offer useful information

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Estimating Costs:

Fixed costs - are those costs that do not vary with production or sales revenue.

Variable costs - are those costs that vary directly with production.

Total costs = Fixed Cost + Variable Cost

(for a given level of production.)

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Break-Even Analysis

Assumptions:total fixed costs are constantvariable costs remain constant

per unit of output.B/E = Total Fixed CostsPrice - Average Variable Costs

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Figure 15-2 Break-Even Chart for Futon Factory

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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

Penetration Pricing

Penetration Pricing

Price set to ‘penetrate the market’‘Low’ price to secure high volumesTypical 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

Market Skimming

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.

Many are predicting a firesale in laptops as supply exceeds demand.Copyright: iStock.com

Value Pricing

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.

Copyright: iStock.com

Loss Leader

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

Psychological Pricing

Psychological Pricing

Used to play on consumer perceptions

Classic example - £9.99 instead of £10.99!

Links with value pricing – high value goods priced according to what consumers THINK should be the price

Going Rate (Price Leadership)

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 share

Where competition is limited, ‘going rate’ pricing may be applicable – banks, petrol, supermarkets, electrical goods – find very similar prices in all outlets

Tender Pricing

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 Mostly done in secret

Price Discrimination

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

Prices for rail travel differ for the same journey at different times of the day

Copyright: iStock.com

Destroyer Pricing/Predatory Pricing

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

Absorption/Full Cost Pricing

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

Marginal Cost Pricing

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

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

Contribution Pricing

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

Target Pricing

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

Cost-Plus Pricing

Cost-Plus Pricing

Calculation of the average cost (AC) plus a mark up

AC = Total Cost/Output

Influence of Elasticity

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

Influence of Elasticity

Price Inelastic:% change in Q < % change in Pe.g. a 5% increase in price would be

met by a fall in sales of something less than 5%

Revenue would riseA 7% reduction in price would lead to a

rise in sales of something less than 7%Revenue would fall

Influence of Elasticity

Price Elastic:% change in quantity demanded > %

change in pricee.g. A 4% rise in price would lead to sales

falling by something more than 4%Revenue would fallA 9% fall in price would lead to a rise in

sales of something more than 9%Revenue would rise