Pricing Strategy and Tactics Session 14 February 19, 1998 Prof. Karen Fox
Agenda • WebBoard Workshop, Media Lab, Varsi Hall, Saturday, February 19, at 9:30 AM • Setting the Price • Pricing Arithmetic • Adapting the Price • Responding to Competitors’ Price Changes • Price Bundling • Legal and Ethical Issues in Pricing
Pricing Fundamentals • Value Orientation • Demand as ceiling, cost as floor • Price and Demand • Price elasticity of demand • Income elasticity of demand • Cross price elasticity of demand • Price as indicator of quality
T76 Fig 17.03 Setting Pricing Policy 1. Selecting the pricing objective 2. Determining demand 3. Estimating costs 4. Analyzing competitors’ costs, prices, and offers 5. Selecting a pricing method 6. Selecting final price
Fig. 17.02 T75 Nine Price/ Quality Strategies Price High Medium Low 1. Premium strategy 2. High- value strategy 3. Super- value strategy High Product Quality 4. Over- charging strategy 5. Medium- value strategy 6. Good- value strategy Medium 7. Rip-off strategy 8. False economy strategy 9. Economy strategy Low
T79 Fig 17.07 The Three C’s Modelfor Price Setting Low Price No possible profit at this price High Price No possible demand at this price Costs Competitors’ prices and prices of substitutes Customers’ assessment of unique product features
T77 Fig 17.04 Inelastic and Elastic Demand $15 $15 Price $10 $10 100 105 50 150 Quantity demanded per period A. Inelastic demand Quantity demanded per period B. Elastic demand
T78 Fig 17.06 Cost Per Unit as a Functionof Accumulated Production $10 $8 $6 $4 $2 Current price - - - - - B A Experience curve T1 - - - - Cost per unit 100,000 200,000 400,000 800,000 Accumulated production
T80 Fig 17.08 Break-even Chart forDetermining Target Return Price and Break-even Volume Total revenue 1200 Targetprofit Total cost 1000 Break-even point 800 600 Dollars (in thousands) 400 Fixed cost 200 0 10 20 30 40 50 Sales volume in units (thousands)
Pricing as Creative Marketing • Understanding buyers’ motivations • Distinguishing segments for pricing • Monitoring use creatively • Product design for effective pricing (See article by same title by Thomas Nagle, Business Horizons, July-Aug. 1983, pp. 14-19)
Price Discrimination • Customer segment • Product form • Image • Location • Time
Time-Based Discrimination • Time of usage • Time of reservation • Time of ticket purchase
Criteria for Price Discrimination • Segments with different responses to price • Identifiable segments and a mechanism to price differently • No opportunity for one segment to sell to another • Large enough segment to warrant differential pricing • Cost of price discrimination strategy should be “worth it” • No consumer confusion due to different prices
Use of Pricing to Smooth Demand for Services • Create demand in off-peak, low-capacity-utilization periods • Flatten peaks in demand by moving existing customers from peaks to less busy times
T81 Fig 17.09 Price-Reaction Program for Meeting a Competitor’s Price Cut Hold our price at present level; continue to watch competitor’s price Has competitor cut his price? No No No Yes Is the price likely to significantly hurt our sales? Is it likely to be a permanent price cut? How much has his price been cut? Yes Yes By less than 2% Include a cents-off coupon for the next purchase By 2-4% Drop price by half of the competitor’s price cut By more than 4% Drop price to competitor’s price
T111 Chapter 17, Question 2 - How One Company Determined the Economic Value to the Customer (EVC) From customer’s point of view: ---------------------- Life-cycle costs Purchase price Startup costs Post-purchase costs (maintenance and operations) Manufacturer’s cost to produce: 1,300 Incremental value $300 EVC = 700 $1,000 1,000 $300 EVC = 600 200 500 200 100 400 300 New product Y New product Z Reference product X $250 $300
T112 Chapter 17, Question 3 - Diagnostic Method Used to Examine and Rate Three Companies’ Offers 50- - 40- - 30- - 20- - 10- - 0 A’ A B Perceived value C | | | | | | .50 1.00 1.50 2.00 2.50 3.00 Price ($)
Price Bundling Price bundling is the practice of marketing and pricing two or more products and/or services in a single package for a “special” price. PURE bundling: The products/services are available ONLY in bundled form. MIXED bundling: The products/services can be purchased individually OR bundled.
The Bundling Decision: • Should the offer be available ONLY in bundled form? • OR should the offer be available EITHER unbundled or bundled, whichever the customer prefers?
Two Approaches to Mixed Bundling 1. Purchase one at regular price, the other service/product is discounted. 2. Purchase both products/services at a price lower than the total of the separate prices.
Motives for Price Bundling • To acquire new customers • To cross-sell additional products/services to existing customers
Advantages of Bundling • Customer saves time and effort by purchasing them together (getting oil at the gas station) • Customer gains increased satisfaction with other products/services by virtue of purchasing the other product/service (ski lessons and ski rental) • Seller’s overall image is enhanced so that customer values all the seller’s products/ services more highly (college career center)
CO. OBJECTIVES: Profit maximization Cost-plus Target rate of return Competition Demand Perceived value ETHICAL ISSUES: Is the price equal or proportional to the benefit received? Is it wrong to charge a price that yields extraordinary profit even when the market is willing to pay the price? Ethical Issues in Price Setting
DEFINED: An excess of total revenue over total cost The return enjoyed by the company as a result of engaging in a successful exchange ETHICAL ISSUES: When is a profit “reasonable”? When is a profit ethical? What considerations should guide analysis of profit? The Concept of Profit
Price Fixing: Illegal • Forbidden by antitrust legislation, which stipulates 1. Businesses must not conspire to monopolize a market. 2. Businesses must not conspire to divide up a market among themselves. 3. Businesses should not conspire to agree jointly as to the prices at which products will be sold.
Reasons for Unethical Pricing • Corporate objectives that overemphasize the profit criterion • Lack of a control system to monitor ethics • Relying on the law “as a floor” • Ambiguous corporate policies • Failure to understand public concern about ethics • Amoral decision making
The Customer As an Equal Partner “The consumer brings needs and expectations to the exchange, is entitled to be fairly treated in the pricing process, and has certain rights that should be respected by the firm.” -- William J. Kehoe
T74 Fig 17.01 How Downward Price Pressure is Determined Consumers shop more carefully Retailers lower their prices Manufacturers lower their prices