Pricing: Considerations and Strategies

Chapters 10 & 11

June 21, 2001

Factors that Affect Pricing Decisions

Internal Factors:• Marketing Objectives - what the firm hopes to

achieve through the 4Ps– survival - low costs– profit maximization = MC=MR (MP=0)– market share - may lower price to gain share– quality - higher price to support quality – competition - crowding out with low prices

• Marketing Mix - price can drive all 3 other Ps, be basis for positioning (target pricing)

Factors that Affect Pricing Decisions (2)

• Costs (determine lower price limit)– Recall from Microeconomics:

• TC=VC+FC• Minimizing SRAC and LRAC curves &

Economies of scale• Learning curve & R&D cost recovery

• Pricing decision-makers in organization– centralized or decentralized– universal or negotiable

Factors that Affect Pricing Decisions (3)

External FactorsExternal Factors• Market (determines upward price limit)

– nature of competition (pure, monopoly, oligopoly)• e.g. Pure competition - market determines price

Monopolistic Competition - range of prices

Pure monopoly - seller alone determines price

– Demand curve and Price elasticity of Demand

– Total supply and competitor pricing/reaction

• Consumer perception of value compared to price• Other environmental issues: government, social

issues, general economic conditions

General Approaches to Pricing3 Approaches:• Cost-Based Pricing:

– Cost-plus Pricing– Breakeven Analysis– Target-Profit Pricing

• Value-Based Pricing• Competition-Based Pricing

– going-rate– sealed-bid

Cost-Based Pricing• Cost-plus Pricing

– unit cost calculated, and standard markup (% of selling price) added - e.g. 40% margin

• Breakeven Analysis– determine graphically or algebraically the relationship

between units sold, costs and revenues to find volume where costs=revenues and set price to match expected sales volumes (based on demand curve)

• Target Profit Pricing - same as above, but for specific profit level (TR-TC)

• Marginal Analysis - maximization of profit where MC=MR

Break-Even Chart

Do

llars

(m

illio

ns)

Do

llars

(m

illio

ns) 1212

1010

88

66

44

22

00

Total costTotal cost

Fixed costFixed cost

Target profitTarget profit$2 million$2 million

Total revenueTotal revenue

100100 200200 300300 400400 500500

Sales volume in units (thousands)Sales volume in units (thousands)

BreakevenBreakeven

$32$41

$20

Value-Based Pricing• Marketing Concept Related

• Considers price to be a key attribute in consumer behaviour

• Identifies consumer perceptions of value and quality and set prices and design products to meet those perceptions

Product CostCost PricePrice ValueValue CustomersCustomers

ProductProductCostCostPricePriceValueValueCustomersCustomers

Value-based pricing

Cost-Based Pricing

Competition-Based Pricing

• Going-Rate Pricing– price is set relative to major competitors,

particularly the industry leader (e.g. gas)– No accounting for differences in costs

• Sealed-bid Pricing– When bidding competitively for contracts -

seek to undercut competitors while still making a profit

– requires estimation of competitor bid

Pricing Strategies

• 4 Issues:–New Product Pricing

–Product Mix Pricing

–Price Adjustment Strategies

–Price Changes

New Product Pricing• Price-Quality Positioning:

• Premium Strategy - high price, high quality

• Economy - low price lower quality (e.g. $ store)

• Good-Value - low price, high quality

• Entry-Pricing Strategy– Market-Skimming - set price as high as possible

and draw revenue from innovators, then lower prices later to capture next adopter group …

– Market Penetration - low initial price in order to maximize penetration into the market

Skimming vs. Penetration

Skimming• Sufficient buyers needed

with inelastic demand• Economies of scale not

important to costs• Barriers to entry (patent)• High prices will not

stimulate under-cutting competitors

• Short PLC• E.g. Intel

Penetration• Price-sensitivity (e.g.

commodities)

• Economies of scale help reduce costs, profits

• Discourage competition with low cost, small margins

• Expected long PLC

• E.g. Dell Computers

Product Mix Pricing StrategiesTaking the entire product mix into account when setting

product prices

• Product lines - need to set steps between product line items to coincide with costs and customer-perceived value. Be aware of established price-points.

• Optional products - additional options/accessories at added price - what should be included? What is luxury?

• Captive (Complementary) Products - pricing in conjunction with main product (e.g. razor blades, movie theatre concessions, bar cover charge)

• Bundling Products - sale of bundles of products at reduced prices to stimulate interest, e.g. software pckg.

Price-Adjustment Strategies

Strategy Description

Discount and allowance pricing*

Segmented pricing

Psychological pricing*

Promotional pricing*

Setting prices to reward customerresponses such as paying early or promoting the productAdjusting prices for differences in time,customers, products, or locations

Adjusting prices for psychological effect

Temporarily reducing prices to increaseshort-run sales

Table 11-2 (page 374)

Price-Adjustment Strategies

Strategy Description

Table 11-2 b

Value pricing

Geographical pricing

International pricing

Adjusting prices to offer the rightcombination of quality and service at afair priceAdjusting prices to account for thegeographic location of customersAdjusting prices for internationalmarkets

Types of Discounts/Allowances• Cash Discount - 2/10 net 30 - due in 30 days, but

2% discount if paid in ten

• Quantity (Volume) Discount - e.g. photocopies

• Trade Discount - Discount to value chain members who perform certain functions such as record-keeping, storage

• Seasonal Discount - off-season discounts (e.g. cruise lines)

• Allowances - trade-in, or promotional allowances for retailers who feature a product to reduce promo costs.

Psychological Pricing

• Price can affect the image, perceived quality of the product - e.g. car, luxury item

• Reference pricing - prices that consumers carry in their heads as “benchmarks” or proxies for quality levels, particularly when past experience and judgment of quality can’t be used.

• Price used as a positioning tool “high-end”

Promotional Pricing

• Loss leaders - price means selling at a loss

• Special event Pricing (Holiday sale)

• Cash Rebates

• Financing offers, extended warranty

Geographical Pricing• How to handle shipping:

– Free on board (FOB) origin pricing - once the product is placed in freight, it becomes the property and responsibility of the customer, who pays for shipping, insurance, etc.

– Uniform delivery pricing - all customers pay a standard shipping fee, such that more local customers absorb the cost of those farther-away

– Zone Pricing - Freight costs set for regions/zones

– Basing Point - freight cost from some base location other than factory (usually central)

– Freight Absorption - seller pays freight

Price Changes• Initiating Price Changes:

• Price cuts to sell off excess capacity (price wars)

• Price increases to offset inflation or resource cost increases

– Consumer Response:

• Quality perception, cyclical waiting for sales

– Competitor Reaction:

• Need to anticipate if they will follow or hold

• Reacting to competitor price changes• Hold & focus on quality or follow - based on PLC,

market share, costs