Pricing Strategies - Exam notes PDF

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Pricing Strategies What is a price?! “The amount of money charged for a product or a service […] the sum of all the values that customers give up to gain the benefits of having or using a product or a service” (Kotler et al, 2017, p.292)!

- Value the customer places on the product! - What are they willing to give up in order to gain price for products?!

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Major Pricing Strategies ! Price Ceiling No demand above this price Customer Perceptions of Value How do we establish a price between these two limits?! There are 3 major pricing strategies Price Floor No profits below this price

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Product Cost

Customer Value Based Pricing

Cost-Based Pricing

Competition Based Pricing

These are the three major pricing strategies.

Cost-Based Pricing ! “Setting prices based on the costs for producing, distributing and selling the product plus a fair rate of return for the effort and risk” (Kotler et al, 2013, p.296) ! In other words, this strategy works upward from the price floor… Types of Cost Fixed Costs (Overheads) - Do not vary with production or sales level ! Variable Costs - Costs that vary directly with the level of production ! Total Costs - Some of fixed and variable costs for any given level of production !

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Two Methods for Rise from Price Floor ! Method 1: Cost-Plus Pricing Unit Cost = Variable + (Fixed Cost ÷ Unit Sales) !

- Company adds desired mark up to the unit cost! - Other companies in supply chain will also add a markup! Example… A toaster has a Variable Cost (e.g. Materials, electricity) of £10 per toaster. ! Fixed costs = £300,000! Expected unit sales: 50,000 = £6 per toaster! Price Floor Unit Cost = £10 + £300,000 ÷ 50,000 = £16! Manufacturer Mark Up = £16 + 20% Mark Up = £20! Retailer Mark Up = £12.50 + 25% Mark Up = £15.63!

Retail Price

Manufacturer desires a 20% mark up. What price should they charge? ! Manufacturer Markup Price = #

£16

= £20!

(1 - 0.2)!

#

The Retailer desires a 50% mark up. What price should they charge? ! Retailer Mark Up Price = #

#

#

£20

= £40!

(1 - 0.5)!

! Unit Cost = £10 + £300,000 ÷ 50,000 = £16!

Price Floor

Manufacturer Mark Up = £16 + 20% Mark Up = £20! Retailer Mark Up = £20.00 + 50% Mark Up = £40!

Retail Price

Method 2: Break-Even Analysis & Target Profit Pricing “Setting price to break even on the costs of making and marketing a product or setting price to make a target return” (Kotler et al, 2013, p.311)

- Use a ‘break even chart’! - Work out how many units we need to sell to break even/achieve target profit ! - If volume is unlikely, a price increase is necessary ! ! Break-Even Volume = #

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#

#

Fixed Cost ! Price-Variable Cost!

Break-Even Volume = £300,000 = 30,000 Units ! #

£20 - £10 !

#

In terms of forecasting these prices and numbers it is imperative to use a ‘Margin of Safety’ this means to be realistic, even pessimistic, in your forecasting. !

Customer Value-Based Pricing! “Uses buyers’ perceptions of value, not the seller’s cost, as the key to pricing”! - Kotler er al (2013, p.306)!

- Focuses on price celling, not the price floor! - “There are two fools in every market - one who asks too much and one who asks too little”! - There are two common examples of value based pricing: ! 1. Good Value Pricing !

- Offering value for money - customers feel like they’re getting a fair deal ! - ‘No / Low Frills’! - Everyday Low Pricing (EDLP)! - Price adjustments ! 2. Value Adding Pricing !

- Attaching valued features and services to differentiate a company’s offers and charging higher prices!

- Augmented product e.g. service quality, convenient delivery ! - Loyalty schemes ! Virgin Atlantic: Flight from London to New York ! Economy - £1,525 ! Upper Class - £6,071!

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Chauffeur Car Service !

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Private Security Channel !

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Luxury Lounge (Clubhouse)!

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Welcome Drinks!

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Luxury Food !

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Comfy Flat Beds!

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Priority Arrival

Competition Based Pricing ! “Setting prices based on competitors’ strategies, prices, costs and market offerings” (Kotler et al.)! What Factors may Influence our Pricing Strategy and Decision Internal Factors:

- Marketing Strategy ! - Marketing Objectives ! - Marketing Mix ! External Factors: Market Type Market Type

Characteristics

Implications for Pricing

Pure Competition (e.g. Copper)

Many Firms ! Homogenous Products

Sellers have little influence over price

Monopolistic Competition (e.g. Restaurants)

Many Firms! Differentiated Products

Can influence price via marketing strategy, less influenced by competitor pricing

Oligopolistic Competition (e.g. airlines)

Few Firms ! Differentiated Products

Highly sensitive to competitors’ pricing strategies

Pure Monopoly (e.g. Water Supply)

One Seller ! Unique Product, no substitutes

Pricing Regulated

Price Elasticity of Demand Price Elasticity - how sensitive is demand to changes in price. !

- If demand hardly changes with a small change in price we say it is inelastic!

- If demand changes greatly we say the demand is elastic ! Buyers are less price sensitive when…! 1. A product is unique ! 2. Product high in quality, prestige or exclusiveness ! 3. Substitute products hard to find ! 4. Cannot easily compare the quality of substitutes ! 5. Expenditure on the product is low compared to income !

Economy - Economic Downturn?

- Consumers cut back on unnecessary expenditures ! - Companies cut prices to increase demand ! - Companies emphasise more affordable items in product mixes! - Companies focus on justifying higher prices ! 4

New Product Pricing Strategies ! Market Skimming VS. Market Penetration ! “Setting a high price for a new product to skim maximum revenues layer by layer from the segments willing to pay the high prices; the company makes fewer but more profitable sales”

- Higher profit margin overall ! - High initial price may offset later price reductions ! - Only works when enough buyers want to buy the product at the initial high price ! Market Penetration Pricing “Setting a low price for a new product to attract a large number of buyers and a large market share”

- Aims to quickly steal market share! - Profit margins lower (may be offset by lower CPU for high sales volume)! - Works in price sensitive markets and when production / distribution costs decrease as sales volume increase ! Product Mix Pricing 1. Product Line Pricing - Setting price steps between products in product line based on cost differences, customer perceptions, and competitor’s prices. ! 2. Optional Product Pricing - Setting price for optional or accessible products along with a main product ! 3. Captive Product Pricing - Setting a price for products that must be used along with a main product ! 4. Product Bundle Pricing - Combining several products and offering the bundle at a reduced price!

Price Adjustments ! Discount and Allowance Pricing This involves prices to reward customers behaviour !

- Quantity discounts ! - Seasonal discount ! - Early payment discount ! - Trade in allowances! - Promotional allowances !

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Segmented Pricing This involves adjustments to allow for different customers, products and locations !

- Customer segment pricing ! - Product form pricing ! - Location based pricing ! - Time based pricing ! Psychological Pricing Adjusting prices for psychological effect ! •

Price as an indicator of quality !

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Odd prices !

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Reference prices !

Geographical / International Pricing This involves deciding what prices to charge in the different areas / countries ! •

How might shipping costs influence the price? !

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Might customers in other countries be willing to pay more for the same product? !

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Might different markets call for different approaches? (e.g. market skimming vs. Market penetration) !

Promotional Pricing Temporarily reducing prices to increase short-run sales by creating excitement & urgency. However if used too frequently, they may have a negative effect. ! •

Discounts !

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Cash rebates !

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Low interest financing !

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Longer warranties !

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Free maintenance !

Pricing in a Digital Age ! Dynamic Pricing:! “Adjusting prices continually to meet the characteristics and needs of individual customers and situations”

- Using customer data (but not age, gender or location) to adjust price - how price sensitive is the customer?

- Often adjusting pricing in ‘real time’

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