PRICING

The Meaning of Price  Price = 1.Value 2.Cost 3.Sacrifices 4.Utility 2

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: Caterpillar Tractor 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!

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”? 4

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 5

Factors Affecting Price 6 Price cost elasticit y Product characteri stic Marketing mix Competiti on Goal/ objective s

Setting Pricing Policy 1.Selecting the pricing objective 2. Determining demand 3. Estimating costs 4.Analyzing competitors’ costs, prices, and offers 5.Selecting a pricing method 6. Selecting final price

Setting Pricing Policy 1.Selecting the pricing objective Survival Maximum current profit Maximum market share Maximum market skimming Product-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

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 11

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.) 12

Break-Even Analysis  Assumptions:  total fixed costs are constant  variable costs remain constant per unit of output.  B/E = Total Fixed Costs  Price - Average Variable Costs 13

Figure 15-2 Break-Even Chart for Futon Factory 14

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 17

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

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

 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

 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

 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)

 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

 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

 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

 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 – 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 = 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

 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

 Calculation of the average cost (AC) plus a mark up  AC = Total Cost/Output

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 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

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