Pricing

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All pricing strategies and their impact

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Pricing

  1. 1. PRICING
  2. 2. <ul><li>Pricing Strategies: </li></ul><ul><ul><ul><ul><ul><li>Penetration Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Market skimming </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Value Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Loss Leader </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Psychological Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Going Rate (Price Leadership) </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Price Discrimination </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Destroyer Pricing/Predatory Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Absorption/Full Cost Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Marginal Cost Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Contribution Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Target Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Contribution Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Influence of Elasticity </li></ul></ul></ul></ul></ul>
  3. 3. <ul><li>Penetration Pricing </li></ul><ul><li>Low Price / High Volume </li></ul><ul><li>Price set to ‘penetrate the market’ </li></ul><ul><li>‘ Low’ price to secure high volumes </li></ul><ul><li>Typical in mass market products – chocolate bars, food stuffs, household goods, etc. </li></ul><ul><li>Suitable for products with long anticipated life cycles </li></ul><ul><li>May be useful if launching into a new market </li></ul>
  4. 4. <ul><li>Market Skimming </li></ul><ul><li>High Price / Low Volume </li></ul><ul><li>High price, Low volumes </li></ul><ul><li>Skim the profit from the market </li></ul><ul><li>Suitable for products that have short life cycles or which will face competition at some point in the future (e.g. after a patent runs out) </li></ul><ul><li>Examples include: Playstation, jewellery, digital technology, new DVDs, etc. </li></ul>
  5. 5. <ul><li>Value Pricing </li></ul><ul><li>Price Based on consumer Perception . </li></ul><ul><li>Price set in accordance with customer perceptions about the value of the product/service </li></ul><ul><li>Examples include status products/exclusive products </li></ul>Companies may be able to set prices according to perceived value.
  6. 6. <ul><li>Loss Leader </li></ul><ul><li>Sold below cost to attract sales or elsewhere </li></ul><ul><li>Goods/services deliberately sold below cost to encourage sales elsewhere </li></ul><ul><li>Typical in supermarkets, e.g. at Christmas, selling bottles of gin at £3 in the hope that people will be attracted to the store and buy other things </li></ul><ul><li>Purchases of other items more than covers ‘loss’ on item sold </li></ul><ul><li>e.g. ‘Free’ mobile phone when taking on contract package </li></ul>
  7. 7. <ul><ul><ul><ul><ul><li>Psychological Pricing </li></ul></ul></ul></ul></ul><ul><li>! Rs. 99 </li></ul><ul><li>Used to play on consumer perceptions </li></ul><ul><li>Classic example - £9.99 instead of £10.99! </li></ul><ul><li>Links with value pricing – high value goods priced according to what consumers THINK should be the price </li></ul>
  8. 8. <ul><li>Going Rate (Price Leadership) </li></ul><ul><li>Price set following leads of Rival </li></ul><ul><li>In case of price leader, rivals have difficulty in competing on price – too high and they lose market share, too low and the price leader would match price and force smaller rival out of market </li></ul><ul><li>May follow pricing leads of rivals especially where those rivals have a clear dominance of market share </li></ul><ul><li>Where competition is limited, ‘going rate’ pricing may be applicable – banks, petrol, supermarkets, electrical goods – find very similar prices in all outlets </li></ul>
  9. 9. <ul><li>Price Discrimination </li></ul><ul><li>Different price, Same goods/service </li></ul><ul><li>Charging a different price for the same good/service in different markets </li></ul><ul><li>Requires each market to be impenetrable </li></ul><ul><li>Requires different price elasticity of demand in each market </li></ul>
  10. 10. <ul><ul><ul><ul><ul><li>Destroyer Pricing/Predatory Pricing </li></ul></ul></ul></ul></ul><ul><li>Aim to force out competitor </li></ul><ul><li>Deliberate price cutting or offer of ‘free gifts/products’ to force rivals (normally smaller and weaker) out of business or prevent new entrants </li></ul><ul><li>Anti-competitive and illegal if it can be proved </li></ul>
  11. 11. <ul><ul><ul><ul><ul><li>Absorption/Full Cost Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Set prices to cover FC and VC </li></ul></ul></ul></ul></ul><ul><li>Full Cost Pricing – attempting to set price to cover both fixed and variable costs </li></ul><ul><li>Absorption Cost Pricing – Price set to ‘absorb’ some of the fixed costs of production </li></ul>
  12. 12. <ul><ul><ul><ul><ul><li>Marginal Cost Pricing </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Set price in relation to MC </li></ul></ul></ul></ul></ul><ul><li>Marginal cost – the cost of producing ONE extra or ONE fewer item of production </li></ul><ul><li>MC pricing – allows flexibility </li></ul><ul><li>Particularly relevant in transport where fixed costs may be relatively high </li></ul><ul><li>Allows variable pricing structure – e.g. on a flight from London to New York – providing the cost of the extra passenger is covered, the price could be varied a good deal to attract customers and fill the aircraft </li></ul>
  13. 13. <ul><li>Contribution Pricing </li></ul><ul><li>Variable/direct costs + contribution to fixed cost </li></ul><ul><li>Contribution = Selling Price – Variable (direct costs) </li></ul><ul><li>Prices set to ensure coverage of variable costs and a ‘contribution’ to the fixed costs </li></ul><ul><li>Similar in principle to marginal cost pricing </li></ul><ul><li>Break-even analysis might be useful in such circumstances </li></ul>
  14. 14. <ul><li>Target Pricing </li></ul><ul><li>Target level of Profit </li></ul><ul><li>Setting price to ‘target’ a specified profit level </li></ul><ul><li>Estimates of the cost and potential revenue at different prices, and thus the break-even have to be made, to determine the mark-up </li></ul><ul><li>Mark-up = Profit/Cost x 100 </li></ul>
  15. 15. <ul><li>Cost Plus Pricing </li></ul><ul><li>Average cost + markup </li></ul><ul><li>Calculation of the average cost (AC) plus a mark up </li></ul><ul><li>AC = Total Cost/Output </li></ul>
  16. 16. <ul><li>Influence of Elasticity </li></ul><ul><li>Price inelastic / Price elastic </li></ul><ul><li>Any pricing decision must be mindful of the impact of price elasticity </li></ul><ul><li>The degree of price elasticity impacts on the level of sales and hence revenue </li></ul><ul><li>Elasticity focuses on proportionate (percentage) changes </li></ul><ul><li>PED = % Change in Quantity demanded/% Change in Price </li></ul>
  17. 17. Influence of Elasticity <ul><li>Price Inelastic: </li></ul><ul><ul><li>% change in Q < % change in P </li></ul></ul><ul><ul><li>e.g. a 5% increase in price would be met by a fall in sales of something less than 5% </li></ul></ul><ul><ul><li>Revenue would rise </li></ul></ul><ul><ul><li>A 7% reduction in price would lead to a rise in sales of something less than 7% </li></ul></ul><ul><ul><li>Revenue would fall </li></ul></ul>
  18. 18. Influence of Elasticity <ul><li>Price Elastic: </li></ul><ul><ul><li>e.g. A 4% rise in price would lead to sales falling by something more than 4% </li></ul></ul><ul><ul><li>Revenue would fall </li></ul></ul><ul><ul><li>A 9% fall in price would lead to a rise in sales of something more than 9% </li></ul></ul><ul><ul><li>Revenue would rise </li></ul></ul>
  19. 19. Example <ul><li>A manufacturer of electrical appliances is continually reviewing its product range and enhancing its existing products by developing new models to satisfy the demands of its customers. The company intends to always have products at each stage of the product life cycle to ensure the company’s continued presence in the market. </li></ul><ul><li>  </li></ul><ul><li>Currently the company is reviewing three products: </li></ul><ul><li>Product K was introduced to the market some time ago and is now about to enter the maturity stage of its life cycle. The maturity stage is expected to last for ten weeks. Each unit has a variable cost of $38 and takes 1 standard hour to produce. The Managing Director is unsure which of four possible prices the company should charge during the next ten weeks. The following table shows the results of some market research into the level of weekly demand at alternative prices: </li></ul><ul><li>Selling price per unit $100 $85 $80 $75 </li></ul><ul><li>Weekly demand (units) 600 800 1,200 1,400 </li></ul><ul><li>Product L was introduced to the market two months ago using a penetration pricing policy and is now about to enter its growth stage. This stage is expected to last for 20 weeks. Each unit has a variable cost of $45 and takes 1.25 standard hours to produce. Market research has indicated that there is a linear relationship between its selling price and the number of units demanded, of the form P = a - bx. At a selling price of $100 per unit demand is expected to be 1,000 units per week. For every $10 increase in selling price the weekly demand will reduce by 200 units and for every $10 decrease in selling price the weekly demand will increase by 200 units. </li></ul>
  20. 20. <ul><li>Product M is currently being tested and is to be launched in ten weeks’ time. This is an innovative product which the company believes will change the entire market. The company has decided to use a market skimming approach to pricing this product during its introduction stage. </li></ul><ul><li>The company currently has a production facility which has a capacity of 2,000 standard hours per week. This facility is being expanded but the extra capacity will not be available for ten weeks. </li></ul>
  21. 21. Solution <ul><li>Solving requirement (a) </li></ul>Product K Selling Price/unit ($) 100 85 80 75 Contribution / unit ($) 62 47 42 37 Demand (units) 600 800 1200 1400 Capacity remaining to produce L 600 standard hours Product L Maximum Production 480 units In order to maximise contribution during its maturity stage product K should be sold for $75 per unit. As a result product L should be sold for $126 per unit during its growth stage
  22. 22. <ul><li>Solving requirement (b) </li></ul>Penetration pricing is based on a much lower selling price, but as a result the demand for the product is much higher so that the volume of sales each making a profit will be used to recover the costs of developing the product. This approach is recommended when the product is similar to others available in the market, i.e. it is not unique. In contrast, skimming is a strategy that charges a high unit price thus making significant profit per unit which can be used to recover the costs of developing the product. This approach requires that the product be unique and in high demand by those that can afford to pay for it, because the level of demand will be relatively low. Product M is a suitable product for a skimming strategy because it is highly innovative and is expected to change the market for this type of product. Solving requirement (c) The company is launching a unique product which will be demanded by high worth customers who are proud to be amongst the first to own such a unique product. This is exactly the type of product for which a skimming pricing policy is appropriate.
  23. 23. Unit Production Costs Production costs are also likely to change throughout the product’s life cycle. Initially production costs may be high due to low volume of activity and the level of fixed costs being incurred to provide the production facility. In addition the labour and related costs are likely to be high as the employees have not yet become experienced in making the product. Growth production cost In the growth stage, production costs per unit are likely to reduce due to economies of scale and because of the impact of the learning and experience curves. The extent of the decrease and its speed will depend on the complexity of the manufacturing process, its similarity to previous products, the experience and level of retention of the workforce Maturity production cost In the maturity stage production costs per unit are likely to remain fairly constant because the learning period will have ended, the workforce will be experienced in producing the products and in handling the raw materials and operating the machinery Decline production cost In the decline stage production costs per unit may increase due to lower volumes and due to the workforce being less interested in a declining product and trying to learn new skills in relation to other products Selling Prices The initial price will be high as this will quickly recover the development costs of the product. The high worth customers will not be deterred from buying the product as it will be sold on the basis of its uniqueness rather than its price.
  24. 24. Growth price Competitors will be attracted to the product by its high price and will seek to compete with it by introducing their own version of the product at much lower development costs (by reverse engineering the product) so it is important for the company to reduce the price during the growth stage of the product’s life cycle. There may be many price reductions during this stage so that the product gradually becomes more affordable to lower social economic groups. Decline price When the product enters the decline stage the price will be lowered to marginal cost or even lower in order to sell off inventories of what is now an obsolete product as it has been replaced by a more technologically advanced item Maturity price As the product enters the maturity stage the price will need to be lowered further, though a normal contribution ratio would continue to be earned.

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