Chapter 11: Pricing Price: the assignment of value, or the amount the consumer must exchange to receive the offering Money, goods, services, favors, votes, or anything else that has value to the other party Value = Benefits/Price Can include monetary and nonmonetary costs, and opportunity costs

Steps in the Price Planning Process

Step 1: Develop Pricing Objectives Sales or market share objectives Profit objectives Competitive effect objectives Customer satisfaction objectives Image enhancement objectives

Step 2: Estimate Demand Forecasting How much of a product are customers willing to buy as its price goes up or down?

The Price Elasticity of Demand How sensitive (responsive) are customers to changes in the price of a product? The percentage change in unit sales that results from a percentage change in price. When changes in price have large effects on the amount demanded, demand is elastic When changes in price have little or no effect on the amount demanded, demand is inelastic

Relationship of TR to price elasticity Price and total revenue work in opposite directions. If price goes down, quantity demanded goes up to a great extent so that TR increases. Know flip side for price increase! Inelastic Price and total revenue change in the same direction. If price goes down, quantity demanded goes up, but only to a small extent; TR actually decreases

Factors that Increase Elasticity of Demand Non-necessities (pizza) generate elastic demand We have to buy necessities regardless of price changes! Availability of close substitute products facilitates elastic demand.

Cross (Price) Elasticity of Demand Effect of price changes on one product on demand for other products. When price of one product goes up: (gas) Demand for substitutes will increase (biofuels; nuclear; wind) Demand for complements will decrease (gas guzzling vehicles)

Step 3: Determine Costs Variable Costs Fixed Costs Total Costs Costs of production that do vary with the number of units produced. Processed Materials, Raw materials Fixed Costs Costs that don’t vary with the number of units produced. Utilities, Equipment Costs Total Costs Sum of the Fixed and Variable Costs for a Set Number of Units Produced

Break-Even Analysis A method to determine the number of units a firm must produce and sell at a given price to cover all its costs. Break-even point: point at which a firm doesn’t lose any money and doesn’t make any profit Any unit a firm sells beyond this break-even quantity will generate a profit.

Step 4: Evaluate the Pricing Environment Review from Ch. 2/3 The economy Broad economic trends Recessions Inflation The competition Industry structure Regulations: Biofuel mandates Consumer trends International influences (exchange rates, dumping, tariffs, etc.)

Step 5: Choose a Pricing Strategy Pricing strategies based on cost Pros: Simple to calculate Cons: Fail to consider several factors (target market, demand, competition, product life cycle, product’s image); difficult to accurately estimate costs Example: Break-even pricing; Cost-plus pricing: total all product costs and add markup

Step 5: Choose a Price Strategy (cont’d) Pricing strategies based on demand Based on estimate of quantity a firm can sell at different prices Target costing (also known as demand-backwards pricing): Identify quality and functionality customers need and the price they’re willing to pay (“sweet spot”) before designing the product. Yield management pricing: charge different prices to different customers to manage capacity often used by services, due to “perishability” (cannot “store” airplane seats or hotel rooms that go unused during non-busy periods)

Step 5: Choose a Price Strategy (cont’d) Pricing strategies based on the competition JM : Price based on value proposition/market position Pricing near, at, above, or below the competition Price leadership strategy: industry giant announces price, and competitors get in line or drop out Common in oligopoly

Step 5: Choose a Price Strategy (cont’d) Pricing strategies based on customers’ needs Value pricing or everyday low pricing (EDLP): pricing strategy in which a firm sets prices that provide ultimate value to customers. Total cost of ownership (not in book): Includes not only the price a customer pays for the product, but also costs of maintaining and using the product over time Energy efficient light bulbs Automobiles (Consumer Reports)

Step 5: Choose a Price Strategy (cont’d) New-product pricing (see next slides) Skimming price: a very high premium price Penetration pricing: a very low price to encourage more customers to purchase to establish a barrier to entry Trial pricing: low introductory price for a limited period of time

Reasons for Using a Skimming Price Strategy Product Benefits that Customers Want at Any Cost. Skimming Price - Charging a High, Premium Price Little Chance that Competitors Can Enter the Market Quickly. Several Customer Segments with Different Levels of Price Sensitivity.

Reasons for Using a Penetration Price Penetration Pricing A New Product is Introduced at a Very Low Price Discourages Competitors From Entering the Market Low Price Encourages Demand and Sales in the Early Stages of the Product Life Cycle

Step 6: Develop Pricing Tactics Pricing for individual products Two-part pricing: offering two separate types of payments to purchase the product Payment pricing: breaking total price into smaller amounts payable over time Pricing for multiple products Price bundling: selling two or more goods or services as a single package for one price Captive pricing: pricing two products that work only when used together

Pricing and Electronic Commerce Online Pricing considerations Consumers gain control Information/knowledge Customers more price-sensitive. Consumers have more negotiating power.

Pricing and Electronic Commerce Dynamic pricing strategies: Seller easily adjusts price to meet changes in marketplace. Cost of changing prices on Internet is practically zero. Firms can respond quickly and frequently to changes in costs, supply, and/or demand. Auctions Traditional: E-Bay Reverse Bots

“The Future of Business is Free” Freenomics: Give products away for free because of the increase in profits that can be achieved by getting more people to participate in a market Example: Comcast gave 9 million subscribers FREE digital video recorders but made money on installation and monthly DVR usage fees An article by Chris Anderson entitled, “Free! Why $0.00 is the future of business” (Wired, March 16, 2008) can be accessed at www.turn.com/corp/index.jsp. Instructors can also access a 3-minute video on this Web site, which discusses the freenomics business model. However, the video is prefaced by a 30-second ad, and the video may not play smoothly, depending upon the user’s connection speed and the time of day the site is visited. Instead of viewing the video on this Web page, instructors may wish to assign this article as an outside of class reading, then use the “scenario” predictions embedded within the article to generate discussion related to the feasibility of these predictions.

Pricing and Consumer Behavior Interesting issues Internal Reference Prices Price/Quality inferences Odd-even pricing Price lining

Deceptive Pricing Practices Bait-and-switch – Consumers “lured” into store for a very low price, but then the item is not available. A more expensive product is offered instead Trading up is acceptable

Unfair Sales Acts Laws or regulations prohibiting selling products below cost “minimum mark-up law” loss leader pricing (to build store traffic) (legal in some states / not in others)

Price Discrimination Means selling the same product to different wholesalers and retailers at different prices (or offering different incentives, i.e., cooperative adv.) Regulated by Robinson-Patman Act only applies to resellers discounts are legal if based on established policy and offered to any customer who chooses to buy under those conditions legal if “proportionate to sales volume”

Price Fixing Occurs when two or more companies conspire/collude to keep prices at a certain level Horizontal price fixing: when competitors making the same product jointly determine what price they each will charge Vertical price fixing: when manufacturers attempt to force the retailer to charge the suggested retail price

Predatory Pricing Means that a company sets a very low price for the purpose of driving competitors out of business