Idil Yaveroglu Lecture Notes Chapter 10 Pricing Idil Yaveroglu Lecture Notes

What is a Price? The amount of money charged for a product or service, or the sum of the values that consumers exchange for the benefits of having or using the product or service. To the seller... Price is revenue and profit source What is Price? To the consumer... Price is the cost of something

Factors to Consider When Setting Prices

Customer Perceptions of Value (no demand above this price) PRICE CEILING Customer Perceptions of Value (no demand above this price) INTERNAL CONSIDERATIONS Marketing Goals Marketing-Mix Strategy Costs Organizational Considerations EXTERNAL CONSIDERATIONS Nature of Market Consumer Demand Competition Environmental Factors PRICE FLOOR Product Costs (no profits below this price)

Pricing Approaches Cost Based Pricing Value Based Pricing Competition Based Pricing

Cost Based Pricing 1. Cost-Based Pricing: Cost-Plus Pricing Adding a standard markup to cost Popular pricing technique because: It simplifies the pricing process Price competition may be minimized It is perceived as more fair to both buyers and sellers Two kinds of mark-up applied: Cost plus percentage of cost Cost plus fixed fee

Disadvantages of Cost Based Pricing Ignores demand (price sensitivity) Does not account for competition May result in underpricing or overpricing

Costs Fixed Costs: Costs that do not vary with sales or production levels. Overhead: Executive salaries, rent Direct Fixed Costs: Advertising, marketing manager’s salary Variable Costs: Costs that do vary directly with the level of production. e.g. raw materials Total Costs (for a given level of production)

Costs Costs at different levels of production (cost changes in short term)

Costs EXPERIENCE / LEARNING CURVE: the drop in average per unit production cost that comes with accumulated production experience.

Cost-Based Pricing Example - Variable costs: $20 - Fixed costs: $ 500,000 - Expected sales: 100,000 units - Desired Sales Markup: 20% Variable Cost + Fixed Costs/Unit Sales = Unit Cost $20 + $500,000/100,000 = $25 per unit Unit Cost/(1 – Desired Return on Sales) = Markup Price $25 / (1 - .20) = $31.25

Cost Based Pricing 2. Cost-Based Pricing: Break-Even Analysis and Target Profit Pricing Break-even charts show total cost and total revenues at different levels of unit volume. The intersection of the total revenue and total cost curves is the break-even point. Companies wishing to make a profit must exceed the break-even unit volume.

Break-Even Analysis and Target Profit Pricing Cost Based Pricing Break-Even Analysis and Target Profit Pricing Revenues 1000 800 600 400 200 Target Profit $200,000 Thousands of Dollars Total Costs Break-even point Fixed Costs 0 10 20 30 40 Quantity To Be Sold To Meet Target Profit Sales Volume in Thousands of Units

Value Based Pricing Value-Based Pricing: Good-Value Pricing Uses buyers’ perceptions of value rather than seller’s costs to set price. Measuring perceived value can be difficult. Consumer attitudes toward price and quality have shifted during the last decade. Good-Value Pricing Everyday low pricing (EDLP) vs. high-low pricing Value-Added Pricing Adding value added features and services to be able to charge high prices

Competition Based Pricing Also called going-rate pricing May price at the same level, above, or below the competition Bidding for jobs is another variation of competition-based pricing Sealed bid pricing

Other Internal and External Considerations Affecting Pricing Decisions Overall Marketing Strategy, Objectives and Mix Company pricing objectives may include; Survival Low prices to cover variable costs and some of fixed costs Current profit maximization Choose the price that maximizes current profit, cash flow or ROI Market share leadership As low as possible to increase market share Product quality leadership High prices to cover higher performance quality

Price vs. Non Price Positioning

Other External Considerations Affecting Pricing Decisions Market Demand Structure Pure Competition Monopolistic Competition Oligopolistic Competition Pure Monopoly

The Demand Curve D Price .50 1.00 1.50 2.00 2.50 20 40 60 80 100 120 20 40 60 80 100 120 Quantity demanded

Shift vs. Movement Along the Curve Demand curve under initial conditions Shift in the demand curve with more favorable conditions Slide 13-28

The Supply Curve Quantity supplied S Price .50 1.00 1.50 2.00 2.50 20 20 40 60 80 100 120

Equilibrium Price Quantity demanded S Price .50 1.00 1.50 2.00 2.50 20 20 40 60 80 100 120 D Surplus Shortage Price Equilibrium

Price Elasticity A. Inelastic Demand - Demand Hardly Changes With a Small Change in Price. Price P2 P1 Q2 Q1 Quantity Demanded per Period B. Elastic Demand - Demand Changes Greatly With a Small Change in Price. Price P’2 P’1 Q2 Q1 Quantity Demanded per Period

Total Revenue and Price Elasticity Percentage change in Q Elasticity (E) = Percentage change in P Inelastic Demand  E < 1  when P increases, TR increases Elastic Demand  E > 1  when P increases, TR decreases Unitary Elasticity  E = 1  P increase is offset by increase in Q  no change in TR

Price Elasticity Buyers are less sensitive to price changes when, Product they are buying is unique When it is high in quality, prestige, or exclusiveness Substitutes are hard to find When the total expenditure for a product is low relative to their income or when cost is shared by another party

Other External Considerations Affecting Pricing Decisions Nature of Market and Demand Competitors’ Strategies Economic Conditions Government Actions