Pricing strategy

Module 7

Learning objectives

Define the term price Distinguish profit-oriented, sales-oriented and status quo pricing objectives Explain the influence of supply and demand on prices Apply the concept of price elasticity and discuss the impact of price changes on total revenue Explain three methods of pricing based on cost and discuss the advantages and limitations of each method.

Learning objectives

Briefly discuss some factors, other than costs, that influence pricing Identify and explain the four steps in setting the price for a product and apply the four-step process to a real-word product or service Use examples to differentiate price skimming, penetration pricing and status quo pricing Identify and briefly discuss some of the legal and ethical issues impacting on pricing.

What is price?

What is given up in an exchange to acquire a good or service. Monetary and non-monetary costs
search costs social costs psychological costs

Money vs. barter

Importance of price

Revenue

price x quantity sold revenue minus costs

Profit

Getting the price right is important

Getting it right can be difficult Need to consider:

perceived value, costs, competitors prices reference prices, opportunity costs

Price is a cue to quality People are becoming more price sensitive

expect value for money

Role of pricing objectives

Objectives should be S.M.A.R.T.

specific measurable attainable realistic time-framed

Provide a benchmark for measuring effectiveness of pricing strategies

Three categories of pricing objectives

Profit-oriented objectives Sales-oriented objectives Status quo objectives

Profit-oriented pricing objectives

Profit maximisation Satisfactory profits Target return on investment

Profit maximisation objectives

Maximise the difference between total revenue and total costs So, why not set a very high price?
perceived value sets the ceiling dont want to attract new entrants need to be competitive avoid government intervention

Satisfactory profits

Acceptable level of profit Matches risk level higher risk leads to higher profit margins

Return on investment objective

Return on total assets ROI = net profit after tax/total assets Are we performing in line with industry ROI average?

Sales oriented pricing objectives

Market share Sales maximisation

Market share pricing objectives

Brand sales/total sales for product category Penetration pricing may be used to gain large market share Large market share means higher production volume which drives costs down However, firms with a smaller market share can still be very profitable

Sales maximisation objectives

Maximise sales volume Does not consider cost of sales or profit

may not be profitable if cost of sales is high

Short-term focus
temporary strategy to improve cash flow clear excess stock end of year sales

Status quo pricing objectives

Maintain existing price or match competitors price

industry wisdom follow the established price leader

Pricing stability
dont rock the boat avoid price wars

examples: airlines, pizza industry, video/DVD hire

Demand impacts on price

Demand is the quantity of goods that will be sold at various prices for a specified period Demand curve
exhibit 11.1, p.395 shows the relationship between price and quantity demanded usually inverse relationship

as price increases, quantity demanded decreases

Price elasticity of demand

How does quantity demanded respond to price changes? Price elasticity of demand = % change in quantity demanded/% change in price

i.e. if price increase of 2% creates a 10% fall in demand then price elasticity of demand = -10/2 = -5

Elasticity of demand
Elastic demand

Inelastic demand

Impact on total revenue

Access to the Interactive elasticity diagram from module 7

Price elasticity cont

Elastic demand
price changes influence demand total revenue decreases when price increases

Inelastic demand
price changes do not affect demand total revenue increases when price increases

What factors affect elasticity?

Availability of substitutes Price relative to purchasing power

if very cheap, price rise wont affect demand fix it rather than replace it if prices are high

Product durability

Products other uses

greater number of uses leads to greater elasticity of demand

Costs impact on price

Costs set the floor for the price Need to cover total costs

fixed costs plus variable costs do not vary with production volume

Fixed costs

Variable costs

vary proportionately with production volume

Mark-up pricing

Add a standard mark-up to the cost of the product First, calculate unit cost

unit cost = variable cost + fixed costs/unit sales

variable cost = $10 fixed cost = $300 000 expected unit sales = 50 000 units

unit cost = $10 + 300 000/50 000 = $16

Second, calculate mark-up price = unit cost / (1- desired return on sales)

desired return = 20% unit cost = $16 then, mark up price = $16 / (1-0.2) = $20 so, profit to manufacturer is $4 per unit

Profit maximisation pricing

Marginal revenue = marginal cost Marginal revenue

the extra revenue associated with selling an extra unit of output or the total change in total revenue associated with one unit change in output change in total costs associated with a one unit change in output

Marginal cost

Break-even pricing

Break-even point

total revenue = total costs

Break-even volume
= fixed costs /(unit selling price - unit variable cost) = 300,000/(20 - 10) = 30,000 units

Target profit pricing - add target return (i.e. plus 20%)

Breakeven analysis
Dollar 1,200,000 10,00,000 800,000 600,000 400,000 200,000 10,000 total revenue
target profit total costs

fixed costs

20,000

30, 000

40,000

50,000

sales volume in units (quantity)

Break even point is 30,000 units

Other external factors that influence price

Stage in product lifecycle

exhibit 11.5, p.402

Competitors prices Distribution strategy

pay extra for convenience

price may be used as a promotional tool price must cover the costs of promotion

Promotion strategy

Demands of large customers Relationship of price to quality

Steps in setting the price

1. Establish pricing goals 2. Estimate demand, costs and profits 3. Select pricing strategy to determine base price 4. Determine pricing tactics to adjust base price

Pricing for new products

New products can be innovative or imitative Innovative products lead to price skimming Imitative products lead to penetration pricing Price reflects positioning Price changes over product life cycle

Market skimming pricing

Suits unique (differentiated) product High price (premium price)

above the market

Maximises revenue

fewer sales but more profits

Quality and image must match high price Cost of producing smaller quantities must not be too high Lower price later to attract more price sensitive markets

Market penetration pricing

Suits standardised products Low price

below the market

Large market share High volume results in lower costs

production and distribution costs fall with volume achieve even greater economies of scale

Penetrate the market Suits price sensitive market

Status quo pricing

Meeting the competition

at the market price

Safe strategy May mean that costs are not covered by firms with smaller production runs May mean that profits are not captured by firms with a differentiated offering

Pricing tactics

Used to adjust the base price

discounts and allowances segmented pricing psychological pricing promotional pricing value pricing geographic pricing international pricing

Discounts and allowances

Reduction to the list price for:

quantity discount - larger quantity purchased

cumulative and non-cumulative

cash discount - early payment functional discount - performing a function (ie returns or delivery) seasonal discount - purchasing out of season promotional allowance (trade allowance) rebate (cash refund)

Value-based pricing

Price is based on consumers perceptions of value

what does the consumer consider to be value? what value is placed on particular attributes/features? what is the consumer prepared to pay?

Sets the ceiling for the price Non-price elements of the marketing mix are used to create value A more creative approach to pricing

can be very profitable

Geographical pricing

FOB origin pricing

buyer pays freight from the shipping point

same freight charged to all locations freight cost varies across zones seller pays freight

Uniform delivered pricing

Zone pricing

Freight absorption pricing

Special pricing tactics

Flexible pricing

Meeting another sellers price

hourly rate charge out rate

Professional services pricing

Loss leader pricing Bait pricing Odd-even pricing

does $4.95 seem cheaper than $5.00? odd numbered pricing implies a bargain even numbered prices imply quality

Price bundling Two-part pricing