Pricing of Food Products APEC 4451 / 5451

University of Minnesota WHAT GOES INTO SETTING A PRICE? Profit, Sales volume, Ethics, Laws, Cost, Promotions, Price discrimination First, Second, and Third Order Price discrimination Charging different prices to different consumers for the same product

First order: Extract all consumer surplus with multiple prices Second order: charge different prices for different blocks of sales Third order: Different consumer demand elasticity in different markets - charge each a different price equating MC to MR in each market.

University of Minnesota Buyers “valuation” of the product/service Price P Q revenue value Consumer surplus

First order price discrimination

Second Degree Price Discrimination

Third Order Price Discrimination

Coca-Cola Vending Pricing Price by the temperature ??? Why not??

Price elasticity University of Minnesota Price elasticity %change in Q / a % change in P The slope of the demand curve Shifts in demand vs. changes in demand P Po Qo What makes it shift?

Consumers have an elasticity of demand => price down and quantity up (even for food) Economic theory (Utility Maximization) & consumer psychology/behavior => get the most Quantity for the price!

Pricing Strategy University of Minnesota I will raise my price to increase my revenue When will this work? ( Necessities, addictive, status, Low % of income, tourist) % increase in price is 10 and % decrease in volume is 5 e = ?? -5/10 = -.5 => inelastic and revenue will increase

Pricing Strategy University of Minnesota Price elasticity e = %change in Q / % change in P P Q Po Qo P1 Q1Q1” Elastic demand: e >1(absolute value) Revenue loss from p increase Inelastic demand: e <1 Revenue gain from p increase

Pricing Strategy University of Minnesota I will cut my price and make it up on volume! When will this work? % decrease in price is 10% and increase in volume is 20% e = ?? 20/-10 = -2 => elastic and revenue will increase

Pricing Strategy University of Minnesota Price elasticity e = %change in Q/ % change in P P Q Po Qo Q2 Q3 Q2= less elastic response Q3 = more elastic response: Gain more revenue with lower price P1

Pricing Strategy University of Minnesota Promotion Loyalty Premium Quality P Q more elastic less elastic Price has less effect on quantity sold.

INCOME EALSTICITY Engle’s Law: As income goes up, the portion of the increase that is spent on necessities (food) decreases. Income elasticity: % change in quantity / % change in income Expenditure elasticity: % change in expenditure on a given food/ % change in income

University of Minnesota Substitutes and complements: Cross price elasticity: 1.% change in quantity of hot dog buns/ % change in price hot dogs e is - => complement 2. % change in quantity of bratwurst/ % change in price of hot dogs e is + => substitute

University of Minnesota How do we measure profit? Profit on sales: Revenue - Total cost = Profit TC = marketing costs+ manuf. Costs + Overhead Costs (2variable + 1fixed) At retail: COGS not a hard number Rebates, promotion dollars, slotting fees etc. Questions of where these show up in profits?

University of Minnesota COGS = $500,000 Promotion $ from manuf. 5% = $25,000 Rebate based on volume 3% on quantity over 100 cases a week ( sell 200 cases: 100x$25/case = $2500x.03=$75) Slotting fee if new product: $100,000 If it is accounted for as a decrease in COGS: $500,000 – 25, ,000 = $374,925

University of Minnesota If it is accounted for as a decrease in COGS: $500,000 – 25, ,000 = $374,925 #1 Revenue: $1,000,000 - COGS: $500,000 = $500,000 Gross Profit –other costs $400,000 = $100,000 Net Profit #2 $1,000,000 - $374,925 = $625,075=> more Gross Profit (lower COGS) $625,075 – $400,000 = $225,075 = Net Profit BUT: tradendollaresnhave to appear somewhere. If add to #1 as revenue,get same net profit as $225,075. Issue of timing: book promotion $ before received.