4/16/2014
What is a Price?
Chapter 10
Pricing

The amount of money charged for a product or service, or the sum of the
values that consumers exchange for the benefits of having or using the
product or service.

Price produces revenue, the other 3P’s represent costs

Easier to change compared to other P’s, more flexible

Customers make inferences based on price
To the seller...
Price is revenue
and profit source
What is Price?
To the consumer...
Price is the cost
of something
Nukhet Harmancioglu
Lecture Notes
INTERNAL FACTORS AFFECTING PRICE
MARKETING GOALS
Factors Affecting Pricing Decisions
1-4
PRICE CEILING
•
Survival
•
Market share leadership
Customer Perceptions of Value
–
(no demand above this price)
INTERNAL CONSIDERATIONS
–
–
EXTERNAL CONSIDERATIONS
Marketing Goals
Nature of Market
Marketing-Mix Strategy
Consumer Demand
Costs
Competition
Organizational Considerations
Environmental Factors
•
As low as possible to increase market share
Prevent competition from entering the market
Current profit maximization
–
•
Low prices to cover variable costs and some of fixed costs
Choose the price that maximizes current profit, cash flow or ROI
Product quality leadership
–
High prices to cover higher performance quality
PRICE FLOOR
Product Costs
(no profits below this price)
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INTERNAL FACTORS AFFECTING PRICE
MARKETING MIX STRATEGY
1-5
INTERNAL FACTORS AFFECTING PRICE
ORGANIZATIONAL CONSIDERATIONS
1-6
•
Price should be consistent with the marketing strategy and objectives
•
Price must be coordinated with other 3Ps
Who sets the price? Who has the authority?
 Keep in mind positioning & the target market
•
Segmentation affects pricing because price varies over segments.
 Price discrimination: Charging different prices to segments
•
For small companies: Top management
•
For large companies: Marketing or sales departments, divisional or
product line managers
•
For industrial markets: Salespeople
•
When pricing is key: Pricing departments
according to their price elasticity or sensitivity.
EXTERNAL FACTORS AFFECTING PRICE
NATURE OF THE MARKET
1-7
EXTERNAL FACTORS AFFECTING PRICE
CONSUMER DEMAND
1-8
•
Pure competition
–
–
•
Monopolistic competition
–
–
–
•
•
Many buyers and sellers trading over a range of prices
Sellers can differentiate their offer to the market
Most FMCG’s
Oligopolistic competition
–
–
Few sellers, each sensitive to others’ pricing and marketing strategies
Komatsu vs. Caterpillar
Pure monopoly
–
–
–
•
Single seller
May not charge full price: prevent entry, faster penetration, fear of regulation
Utilities
Consumers compare the Perceived Value of the alternatives
 In general, consumers buy if perceived value > price
Many buyers and sellers who have little effect on price
Commodity markets such as wheat, copper
•
Price Elasticity of Demand: how responsive the demand will be to a change
in price.
 What does elasticity depend on?
• Higher elasticity (ease of not buying)
–
–
•
Availability of substitutes
Inventory capabilities
Lower elasticity
–
–
–
–
Price=quality assumptions
Uniqueness
Low price relative to budget
Purchasing for someone else
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Price
Price Elasticity
Total Revenue and Price Elasticity
A. Inelastic Demand Demand Hardly Changes With
a Small Change in Price.
P2
Percentage change in Q
P1
Elasticity (E) =
Percentage change in P
Price
Q2 Q1
Quantity Demanded per Period
P’2
Inelastic Demand  E < 1  when P increases, TR increases
B. Elastic Demand Demand Changes Greatly With
a Small Change in Price.
Elastic Demand  E > 1  when P increases, TR decreases
Unitary Elasticity  E = 1  P increase is offset by increase in Q
 no change in TR
P’1
Q2
Quantity Demanded per Period
Q1
Total Revenue and Price Elasticity
Price Elasticity
11

Buyers are less sensitive to price changes when,

Product they are buying is unique

When it is high in quality, prestige, or exclusiveness

Substitutes are hard to find

When the total expenditure for a product is low relative to their
income or when cost is shared by another party
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EXTERNAL FACTORS AFFECTING PRICE
COMPETITORS’ PRICES AND COSTS
1-13
PRICING APPROACHES:
1. COST-BASED PRICING
1-14
•
•
Market share depends on the “Perceived Value / Price” ratio
•
Price = Cost + Mark-up
What do we gain by learning competitors’ costs?
•
Why is it popular?
–
–
•
How can you estimate competitors’ costs?
–
–
•
–
–
–
–
How low can they cut prices
Profits made, market entry / exit ?
Reverse engineering
Public data
Competitors are most likely to react to price changes WHEN:
–
–
–
•
Simple
Sellers are more certain about costs than demand
Minimizes price competition
Perceived fairness to both buyers and sellers
Break-Even Analysis for pricing: Evaluating various prices by looking at BE
Volumes.
Number of firms is small
Products are similar
Buyers are informed
Disadvantages of Cost Based Pricing
Costs

Ignores demand (price sensitivity)

Does not account for competition
Fixed Costs: Costs that do not vary with sales or production levels.
–
Overhead: Executive salaries, rent

May result in under-pricing or over-pricing
–
Direct Fixed Costs: Advertising, marketing manager’s salary
Variable Costs: Costs that do vary directly with the level of production.
–
e.g. raw materials
Total Costs (for a given level of production)
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1. COST-BASED PRICING
1. COST-BASED PRICING
- Variable costs: $20
- Expected sales: 100,000 units
- Fixed costs: $ 500,000
- Desired Sales Markup: 20%
Break-Even Analysis and Target Profit Pricing
Variable Cost + Fixed Costs/Unit Sales = Unit Cost
$20 + $500,000/100,000 = $25 per unit

Break-even charts show total cost and total revenues at different levels
of unit volume.

The intersection of the total revenue and total cost curves is the breakeven point.

Companies wishing to make a profit must exceed the break-even unit
volume.
Unit Cost/(1 – Desired Return on Sales) = Markup Price
$25 / (1 - .20) = $31.25
1. COST-BASED PRICING
2. VALUE-BASED PRICING
1-20
Break-Even Analysis and Target Profit Pricing
Revenues
1000
Thousands
of Dollars
Target Profit $200,000
800
Total Costs
Break-even
point
600
400
Rationale:
• Customers generally don't know and care about your margins or costs.
• Customer assessments of value are based on their personal gains and
losses provided by competing alternatives.
•
•
Determine price using perceived value to buyers
Hence, start by analyzing customer needs and value perceptions
Fixed Costs
200
0
10
20
30
Sales Volume in Thousands of Units
40
Quantity To Be Sold To Meet
Target Profit
halogen
fluorescent
LED
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Price vs. Non Price Positioning
2. VALUE-BASED PRICING
1-21
Cost-Based Pricing
vs.
Product
Value-Based Pricing
Product
Cost
Cost
Value to the Buyer
Price
Price
Value to the Buyer
Cost
Product
3. COMPETITION BASED PRICING

Competition-Based Pricing:

Also called going-rate pricing

May price at the same level, above, or below the competition
New Product Pricing Strategies


Market-Skimming Pricing

Setting a high price for a new product to skim maximum revenues layer by
layer from segments willing to pay the high price.

Results in:

Fewer sales

Higher unit margins
Market-Penetration Pricing

Setting a low price for a new product in order to attract a large number of
buyers and a large market share.

Results in:
–
Larger market share
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Price Skimming
Price Skimming
Penetration Pricing
Strategy
Skimming Pricing
Strategy
Maturity
Decline
Year
Price
1906
1912
1925
$825
$575
$290
Ford T Model
Growth
Introduction



High initial price for quick ROI
Inelastic demand
Price insensitivity by the market
Product Mix Pricing Strategies
Price Penetration
Skimming Pricing
Strategy
Penetration Pricing
Strategy
Maturity
Growth
Introduction



Low initial price with elastic demand
Volume for lower production costs
Imminent competition

Product Line Pricing

Setting price steps between product line items.

Decline


Price points
Optional-Product Pricing

Pricing optional or accessory products sold with the main product

Eg. Cars and accessories, Computer and extras etc.
Captive-Product Pricing


Pricing products that must be used with the main product

High margins are often set for supplies

HP vs Kodak pricing strategy
Services: two-part pricing strategy

Fixed fee plus a variable usage rate

Eg. Disneyland
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Product Mix Pricing Strategies

By-Product Pricing


Pricing low-value by-products to get rid of them
Product Bundle Pricing

Pricing bundles of products sold together
Price Adjustment Strategies






Discounts and Allowances

Discounts: Straight reduction in price on purchases during a certain time
period

Cash discount
Quantity discount
Functional (trade) discount

Seasonal discount



Segmented Pricing Strategies


Trade-in allowances
Promotional allowances
Types of segmented pricing strategies:

Customer-segment

Product-form pricing

Location pricing

Time pricing


Allowances: Reward price deductions in return for an agreement to pay
early or other.

Discount / allowance
Segmented
Psychological
Promotional
Geographical
International


Winnie the pooh versions
Out of state tuition
Resorts
Referred to as yield management when
used for fixed capacity

Airlines, cruises, hotels etc.
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Psychological Pricing
Movie theatres,
resorts and hotels
often use segmented
pricing for children
Price Quality Relationship

The price is used to say something about the product.

Price-quality relationship

Reference prices: Price used as a benchmark for comparison

Differences as small as five cents can be important

Numeric digits may have symbolic and visual qualities that psychologically
influence the buyer
Odd-Even Pricing

Low cost focus
Differentiation
focus/ quality
Odd Even Pricing (Psychological Pricing): The practice of setting prices a
few dollars or cents below an even number

Odd-number prices imply bargain

price
Lower Prices


unique
Higher Prices
Customers uncertain about brand quality prior to purchase look to price
Customers look to price in high risk purchases

Eg. Gasoline prices: 1.4599
 Oil Change $19.99
 Car Wash $9.99
Even-number prices imply quality

Eg. Rolex watch for $450
 Ralph Lauren Romance Perfume $65
 Organic Chips $3.00
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Promotional Pricing

Temporarily pricing products below the list price or even below cost
Promotional Pricing Problems
Loss leaders
 Pricing a few items low to lure customers

Easily copied by competitors

Creates deal-prone consumers
Special-event pricing
 Seasonal items priced low

May erode brand’s value

Not a legitimate substitute for effective strategic planning

Cash rebates
 For purchases completed within a time frame

Frequent use leads to industry price wars which benefit few firms

Low-interest financing, longer warranties, free maintenance



Promotional Pricing
Promotional pricing can have adverse effects
Customer Reaction to Price Changes
Price Cuts – Negative Buyer Reaction?
Customer Reaction to Price Changes
Promotional Pricing
1-40
•
•
Normally should increase demand
But other possible customer beliefs:
–
–
–
–
It’s going to be replaced by newer models
Current models are not selling well
Company is in financial trouble
Quality has been reduced
When Gibson lowered its prices,
sales fell. Why? What is it about a
guitar that would cause this to
happen? What other products
share these qualities?
•
Promotions may cause consumers:
–
–
–
To switch to the promoted brand
To buy more than usual of the promoted brand
(stockpiling)
To expect lower prices in the future
•
Promotions may reduce the value of the brand
in the eyes of the buyers
•
Promotions may create “deal prone” customers
who wait for promotions (bargain hunters, or
promotion oriented customers)
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Price Changes

Initiate price cuts when a firm:
Dynamic Pricing

Initiate price increases when a firm:

Has excess capacity

can increase profit

Faces falling market share due to
price competition

faces cost inflation

faces greater demand than can be
supplied

Desires to be a market share
leader
Adjusting prices continually to meet the characteristics and needs of
individual customers and situations

Monitoring demand / price continuously

Basic Quantitative Analysis - Pricing
1-43

e.g. pricing of airline tickets

Can create customer dissatisfaction, protests

Eg. Amazon, Dell
Key Concepts - Costs
1-44


Sales figures for different prices:
Sales (weekly)
Price ($)
600
7.50
700
6.00
1000
5.00
What is the best price?
We need cost information!!

Fixed Costs do not vary with production or sales level.

Variable Costs vary directly with the level of production.

Total Cost
= Fixed cost + Total variable cost
= Fixed cost + k V where V is volume/quantity;
k is unit variable cost
Cost in $
Total Cost
Fixed Cost
Quantity in units
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Key Concepts - Contribution
1-45
Pricing Example
1-46



Unit Contribution
= Price - Unit variable cost
=P–k
Amount that each unit contributes to covering fixed costs.

= Total revenue-total variable cost
= PV – k V
=(P–k)V
Amount available to the firm to cover (or contribute to) fixed cost and
profit after the variable cost has been deducted from total revenue.
Sales figures for different prices:
Total Contribution

Sales (weekly)
Price ($)
600
7.50
700
6.00
1000
5.00
What is the price that maximizes total contribution if the unit
variable cost k is $4?
Profit = Total revenue – Total cost = Total contribution – Fixed cost
= P V – FC – ( k  V )
= ( P – k ) V – FC
Key Concepts - Margin
1-47
Channel Structure / Price Changes
1-48

Margin = selling price – acquisition price of a good
p = $8
p = $12
Wholesaler
( also called unit contribution, or markup )

Percent margin = margin / selling price
Manufacturer
Unit cost = $5
Margin ($)=
($): 8-5= $3.00
Margin (%)=
(%): 3/8= 37.5%
p = $10
Retailer
Customer
Selling Price - Cost of Good Sold
10-8= $2.00
12-10= $2.00
Margin ($) / Selling Price
2/8= 25%
2/12= 16.7%
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Break-even Volume
Break-even Volume - Example
1-49
1-50

Point at which profit is zero

Point at which revenues = costs

Minimum amount of sales to cover total costs
BE Volume =
Migrosoft manufactures and sells pillows:
Fixed Costs
Unit Contribution
$$$

Total Revenue
A tool to evaluate the feasibility of

price per unit: $10

variable cost: $5.5/unit

fixed costs: $15,000

what is the BE Volume?
Total Cost
a prospective strategy. The idea
is to determine the amount of
sales the strategy must generate
in order for it to at least pay for
BEV
Quantity
itself.
Break-even Volume - Example
1-51
Shall we offer a 5% price discount?
1-52
Migrosoft average monthly sales and costs are:

Sales:
4000 units

Price per unit :
$10

Variable cost:
$5.50/unit

Fixed cost:
$15,000
Management is considering offering a 5% price cut, and has asked you to
determine by how much sales would have to increase for them to benefit
from the price cut?
Current
Price cut
situation
(5% discount)
Price per unit :
Sales:
Variable cost:
Unit contribution:
Total contribution:
By how much sales would have to increase to benefit from the price cut?
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Shall we offer a 5% price discount?
1-53
Shall we offer a 5% price discount?
1-54
Price per unit :
Current
Price cut
Current
Price cut
situation
(5% discount)
situation
(5% discount)
Price per unit :
$10
Sales:
$10
Sales:
4000 units
Variable cost:
Variable cost:
Unit contribution:
Unit contribution:
Total contribution:
Total contribution:
By how much sales would have to increase to benefit from the price cut?
By how much sales would have to increase to benefit from the price cut?
Shall we offer a 5% price discount?
1-55
Shall we offer a 5% price discount?
1-56
Current
Price cut
Current
Price cut
situation
(5% discount)
situation
(5% discount)
Price per unit :
$10
Price per unit :
$10
Sales:
4000 units
Sales:
4000 units
Variable cost:
$5.50/unit
Variable cost:
$5.50/unit
Unit contribution:
Unit contribution:
$4.50/unit
Total contribution:
Total contribution:
By how much sales would have to increase to benefit from the price cut?
By how much sales would have to increase to benefit from the price cut?
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Shall we offer a 5% price discount?
1-57
Shall we offer a 5% price discount?
1-58
Current
Price cut
Current
Price cut
situation
(5% discount)
situation
(5% discount)
$9.5
Price per unit :
$10
Price per unit :
$10
Sales:
4000 units
Sales:
4000 units
Variable cost:
$5.50/unit
Variable cost:
$5.50/unit
Unit contribution:
$4.50/unit
Unit contribution:
$4.50/unit
Total contribution:
$18,000
Total contribution:
$18,000
By how much sales would have to increase to benefit from the price cut?
By how much sales would have to increase to benefit from the price cut?
Shall we offer a 5% price discount?
1-59
Shall we offer a 5% price discount?
1-60
Current
Price cut
Current
Price cut
situation
(5% discount)
situation
(5% discount)
Price per unit :
$10
$9.5
Price per unit :
$10
$9.5
Sales:
4000 units
V units ?
Sales:
4000 units
V units ?
Variable cost:
$5.50/unit
Variable cost:
$5.50/unit
$5.50/unit
Unit contribution:
$4.50/unit
Unit contribution:
$4.50/unit
Total contribution:
$18,000
Total contribution:
$18,000
By how much sales would have to increase to benefit from the price cut?
By how much sales would have to increase to benefit from the price cut?
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Shall we offer a 5% price discount?
1-61
Shall we offer a 5% price discount?
1-62
Current
Price cut
Current
Price cut
situation
(5% discount)
situation
(5% discount)
Price per unit :
$10
$9.5
Price per unit :
$10
$9.5
Sales:
4000 units
V units ?
Sales:
4000 units
V units ?
Variable cost:
$5.50/unit
$5.50/unit
Variable cost:
$5.50/unit
$5.50/unit
Unit contribution:
$4.50/unit
$4/unit
Unit contribution:
$4.50/unit
$4/unit
Total contribution:
$18,000
Total contribution:
$18,000
$4 x V
By how much sales would have to increase to benefit from the price cut?
By how much sales would have to increase to benefit from the price cut?
V = 18,000 / 4 = 4,500 units: 500 units increase
Shall we offer a 5% price discount?
1-63
Shall we offer a 5% price discount?
1-64
Current Price cut
Current
Price cut
situation
(5% discount)
Price per unit :
$10
$9.5
Price per unit :
$10
$9.5
Sales:
4000 units
V units ?
Sales:
4000 units
V units ?
Variable cost:
$5.50/unit
$5.50/unit
Variable cost:
$5.50/unit
$5.50/unit
Unit contribution:
$4.50/unit
$4/unit
Unit contribution:
$4.50/unit
$4/unit
Total contribution:
$18,000
$4 x V
Total contribution:
$18,000
$4 x V
Fixed cost:
_________________________
Fixed cost:
$15,000
$15,000
Total profits:
situation(5% discount)
Total profits:
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Shall we offer a 5% price discount?
1-65
Break-even Change Analysis
1-66
Current Price cut
situation(5% discount)
Price per unit :
Sales:
Variable cost:
Unit contribution:
Total contribution:
Fixed cost:
Total profits:
$10
4000 units
$5.50/unit
$4.50/unit
$18,000
$15,000
$3,000
$9.5
V units ?
$5.50/unit
$4/unit
$4 x V
$15,000
$(4 x V - 15,000)

BE can be used to evaluate the profitability of a price change

A price change will break-even if:
Total contribution with new price
(Unit sales with new price x profit margin with new price)
is greater than
Total contribution with current price
Fixed cost are the same in both situations ($15,000) – so they don’t affect
the break-even change analysis
(Unit sales with current price x profit margin with current price)
Break-even Change Analysis
Break-even Change Analysis
For a Fixed Cost Change
1-67
1-68
Migrosoft Average monthly sales and costs are:

Sales:
4000 units

Price per unit :
$10

Variable cost:
$5.50/unit

Fixed cost:
$15,000
Management is considering running an advertising campaign to boost
the sales. They obtained a proposal from an advertising agency for a new
advertising campaign at a total cost of $30,000.
Should you do it?

Used to evaluate the profitability of a change in the level of marketing or
operational investments (fixed costs changes)

A change in our investment level breaks even if:
Total profit at new investment level
(Sales at new investment level x Margin at new investment level – new
fixed cost)
is greater than
Total profit at current investment level
(Sales at current investment level x Margin at current investment level –
current fixed cost)
17