Pricing Strategy

What Is a Price?

• Narrow Definition: The amount of money charged or paid for a product or service.

• Broad Definition: The sum of all values consumers exchange for the product or service.– Time Costs– Cognitive and Emotional Costs– Transaction Costs

Internal and External Factors Affect Prices

Value-Based Pricing vs. Cost-Based Pricing

• Cost-plus pricing– Add a standard markup to the cost of the product

• Break-even pricing– Pricing to break-even (Why?!)

• Target-profit pricing– Pricing to meet a profit objective.

Cost-Based Pricing Methods

• Fixed Costs: Costs that do not vary with production or sales level.

• Variable Costs: Costs that vary directly with the level of production.

• Mixed Costs: Costs that have both fixed and variable components.

Fixed vs. Variable Costs

Estimating Costs

• Experience/learning curve

Markup Pricing

• Add a standard markup to the product’s cost

Target-Return Pricing

• Price that yields its target rate of return on investment

Cost-Volume-Profit Graph

• Marketing Mix Strategy:– Price must be coordinated with the other three P’s

(Product, Promotion and Place) to form a consistent and effective marketing program.

Internal Factors Affecting Pricing Decisions

• Supply and Demand Curves• Pricing in different types of markets:

– Pure competition– Monopolistic competition– Oligopolistic competition– Pure monopoly

• Price elasticity of demand• Cross-price elasticity of demand• Price Sensitivity

External Factors Affecting Pricing Decisions

Price Sensitivity

Inelastic And Elastic Demand

What kind of markets do the following companies/products compete in?

(Pure competition, Monopolistic Competition, Oligopoly, or Pure Monopoly)

External Factors Affecting Pricing Decisions

• Competition’s Prices Affect Our Price– What are our competitors charging? How and Why?– Will our pricing attract, restrict, or drive out competitors?– How does our value compare to the competition’s?– How strong/permanent are current competitors?– How does competition influence price sensitivity?– Avoiding price wars

• Other External Economic Factors– Inflation– Purchasing Power– Business Cycle (Expansion vs. Contraction)– Counter-cyclical products

Questions du Jour

Which products sell better in a bad (i.e. contracting) economy?

Can companies ever raise prices in a bad economy?

• Best used when:– Higher quality /

”premium” product.– Lower fixed cost

structure.– Competitors with

similar quality cannot easily undercut price.

– Initially set a high price for a new product so as to “skim” revenues layer by layer from the market.

– Lower prices over time, “skimming” revenue from different demand tiers.

– Initially make fewer, but more profitable sales.

New-Product Pricing Strategies – Market Skimming

• Best used when:– Market is highly price

sensitive.– High fixed cost

structure.– Competitive

response does not create a price war.

– Set a low initial price to “penetrate” the market quickly.

– Possibly raise prices when wide adoption and brand loyalty have been achieved.

New-Product Pricing Strategies – Penetration Strategy

Which pricing strategy (skimming or penetration) is normally used when a new prescription drug is introduced in the U.S.?

Why?

Product Mix Pricing Strategies

• Product line pricing• Optional-product

pricing• Captive-product pricing• By-product pricing• Product bundle pricing

Product Line Pricing

• Sets price steps between various product line items based on:– Cost differences between

products– Customer demand for

additional/different features

• Price-Value Gradients

Optional-Product Pricing

• Pricing optional or accessory products sold with the main product

• Examples: – Cruise control added to basic car.– Computer sold with additional RAM (memory)– Rental car sold with “luxury” or size upgrade

• Ethics alert!! Often abused in “Bait and Switch” tactics

Captive-Product Pricing

• Pricing products that must be used with the main product

• Base product is relatively “cheap” or free• Replacement product is relatively “expensive”• Examples:

– Replacement cartridges for Gillette razors.– Toner/ink for printers.– Replacement car parts sold at car dealers

Product Bundle Pricing

• Multiple products sold together for one price• Creates perception of savings• Eases decision-making and ordering for consumers• Examples:

– Computer package: PC, monitor, software, and printer.– McDonald’s Value Meal: Burger, Fries and Drink– Vacation package: Flight, hotel and meals

Question du Jour

When are companies better off bundling prices?

When are companies better off charging separate prices for each item?

• Discount and allowance pricing• Price discrimination (Segmented pricing)• Psychological pricing• Promotional pricing• Dynamic pricing

Price Adjustment Strategies

Discounts and Allowances

• Discounts– Cash– Quantity– Seasonal

• Allowances– Trade-in– Promotional

• Dangers of discounts

Seasonal Discount: Christmas cards purchased out of season, such as in March or July, are often sold at a discount.

Price Discrimination (Differentiated / Segmented Pricing)

• Selling a product or service for different prices to different people, where differences in price are not driven by different costs.

• Types:1. First Degree – by person2. Second Degree – by volume3. Third Degree – by market segment

Pricing at Disney World hotels varies by time of year.

Price Discrimination

• Yield pricing

Psychological Pricing

• Considers the psychological effects of prices – usually irrational responses.

• Economic consideration of prices diminished.• Standard practice among most retailers

Odd-Even Pricing

• Why do marketers use the following prices?

Question du Jour

What impression are consumers left with when they see even-numbered prices like

$12 ?

Price as Signal of Quality

• The typical Price-Quality Inference

• Effects of price changes on quality inferences

• When pricing is NOT used as a quality signal– Extensive product knowledge/expertise– Repeat buys

Reference Prices

• What is a fair price for gas?

Possible Consumer Reference Prices

• “Fair” Price• Average Price• Typical price• Last price paid• Upper-bound price• Lower-bound price• Competitor prices

• Expected future price• Usual discounted

price• Phantom prices

Promotional Pricing Techniques• Cash Rebates• Special-Event Pricing• Loss Leaders• Longer Payment

Period• Low-Interest (or

Free) Financing• Deals (BOGOs)• Clearance Sales

Promotional Pricing – Deals, Clearance Sales and 0% Financing

Promotional pricing creates excitement and a sense of urgency.

Hi-Low Pricing vs. EDLP

Which strategy is more profitable?

Initiating Price Changes• Price cuts

– Falling sales or market share – demand issues– Grab market share from competitors– Lower production/service costs– Respond to competitor’s price drop– Consumers have less purchasing power

• Price Increases– Cost inflation– Over-demand– Match competitor’s increase– Market leadership– Time

How would consumers likely react if Joy suddenly cut its price in half?

When Cutting Price is a Bad Idea

Assessing and Responding to Competitor Price Changes

Understanding Pricing

• Pricing in a digital world

• Dynamic pricing• Price comparisons• Check/compare prices at the point of purchase• Name your price and negotiate prices online• Monitor customer behavior & tailor offers• Automatic rebates and refunds

Internet Price Shopping

Have consumers benefitted?

Public Policy Issues in Pricing