Economics of Pricing Strategies Introduction to Economics of Pricing Strategies Faculty: Prof. Sunitha Raju Session Date: 16.12.2012

Business Decision Making – Why? Economic system operates under certain guiding principles Scarcity & trade-offs (choice) Economic interactions (specialisation) Rule based (incentives) Allocation Issues for a firm Optimise resource use Efficient pricing Maximise profits/ value

Firm and Goals (1) Definition of a Firm/Market Basis of Corporate Strategy what products/services will firm offer for sale who will be the firm’s customers What should the firm continue to do or plan to abandon How does the firm’s strategy align with the market and competitive realities How should a firm compete against its market rivals

Firm and Goals (2) Trade-offs among Alternate goals To pursue short run profits or long run profits To improve profit margins or increase market share To increase penetration of existing markets or enter new markets To diversify into related products or into unrelated products To seek faster growth or stability

Theory of Firm – Some Basics Based on the objective of Project Maximisation Transaction Costs (uncertainty, asset-specificity) Market vs. non-market issues for organising a business activity Reducing transaction costs by incentivising employees (trade-off) bonuses, perquisites, stock options

Modern Corporation : Principal – Agent Problem Owners & Managers of firm differ with different objectives Profit maximisation is constrained by limited information available to managers Optimisation vs. satisfying Alternate theories of firm Value maximisation

What is Value Maximisation? Inputs Process Output Value creation

Business Firm’s Decisions (1) Objective of Profit Maximisation Total Revenue and Total Cost What to supply, How much to supply and Where to supply Price : Economic Properties Measure of scarcity Signals to both consumers and producers for efficient decision making Determined in markets where demand and supply forces interact Price Controls lead to Market distortions

Business Firm’s Decisions(2) Pricing Decision issues Product demand and Supply curves Efficient price and Output Markets and Price level A Systematic Approach to Pricing Price Environment Price Determination Price Strategy

Structure of Car Sector YEAR/ COMPANY HML PAL MARUTI MS PAT (RS. LAKHS) 1983-84 52.9 NA 46.2 610 - 1985-86 23.4 29.1 1146 47.0 300 1989-90 15.9 272.5 23.6 1717 60.4 4194 1991-92 12.6 (1820.4) 18.77** (169.7) 68.8 3539* 1992-93 15.7 (3049.5) 11.3 69.5 3661 1993-94 12.4 1756 11.9 (2241) 72.4 13600* 1994-95 9.8 10.5 75 HML : HINDUSTAN MOTORS LIMITED PAL : PREMIER AUTOMOBILE LIMITED MS : MARKET SHARE PAT : PROFIT AFTER TAX : PROFIT BEFORE TAX (PBT) ** : FOR 9 MONTHS

Decision Making Framework of a Firm Business and Social Environment Market Environment Customer Demand Level of Competition Supplier Capability Legal Environment Tax Burden Regulatory Policy Trade Policy Technology Production Capacity Worker Knowledge Communications Capability Research and Development Competitive Strategy Product Choice Pricing Strategy Promotion Strategy Organisation Design Assignment of Decision Rights Match Worker Incentives with Managerial Motive Decision Management and control Pay for Performance Worker Pay for Performance Divisional Pay for Performance Management Pay for Performance Shareholder Value Maximization

Categories of Goods & Services Rival Consumption Yes No Private Goods Collective goods (Theater) (Car or Coke) No Yes Exclusion Commons Public Goods (Ocean Fishery) (National Defense)

Firm and Goals (1) Stages of corporate development Definition of a Firm/Market Basis of Corporate Strategy what products/services will firm offer for sale who will be the firm’s customers What should the firm continue to do or plan to abandon How does the firm’s strategy align with the market and competitive realities How should a firm compete against its market rivals

Firm and Goals (2) Firm’s Strategic Alternatives Profit Maximisation Concentration on a single business Vertical integration Horizontal integration Diversification Joint ventures Innovation Profit Maximisation Compensatory and functional theories of profit Frictional and Monopoly theories of profit Technology and Innovation theories of profit Contd…

Firm and Goals (2) Trade-offs among Alternate goals To pursue short run profits or long run profits To improve profit margins or increase market share To increase penetration of existing markets or enter new markets To diversify into related products or into unrelated products To seek faster growth or stability

Market Framework for Firm’s Decision Demand and Supply factors determine market price Price always tends toward equilibrium (iii) Price serves as a rationing mechanism