10-1 © 2006 by Nelson, a division of Thomson Canada Limited 10/23/2015 Slides developed by: Peter Yannopoulos Chapter 10 Pricing Strategy

10-2 © 2006 by Nelson, a division of Thomson Canada Limited Strategic pricing involves finding a balance between the customer’s desire to obtain good value and the firm’s need to cover costs and earn profits Thomas T. Nagle and Reed K. Holden, The Strategy and Tactics of Pricing Essence of Pricing

10-3 © 2006 by Nelson, a division of Thomson Canada Limited Strategic Influences on Price Strategic Influences on Price Perceived Customer Value Cost Competition Marketing Strategy Pricing Objectives Single Versus Multiple Product Line

10-4 © 2006 by Nelson, a division of Thomson Canada Limited Price Elasticity of Demand P1 P2 Q2 Q1 Price Quantity

10-5 © 2006 by Nelson, a division of Thomson Canada Limited The Price Elasticity of Demand Equation  Q/Q E = -  P/P

10-6 © 2006 by Nelson, a division of Thomson Canada Limited Price Elasticity of Demand Example ( – )/ E = - ( )/100 = -2.5

10-7 © 2006 by Nelson, a division of Thomson Canada Limited Cost and Price Dynamics

10-8 © 2006 by Nelson, a division of Thomson Canada Limited A Typical Experience Curve Log Cumulative Industry Output Log Cost per Unit (in real dollars) Industry Costs

10-9 © 2006 by Nelson, a division of Thomson Canada Limited Sources of the Experience Curve Effect Product redesign and standardization Technological advances Learning Economies of scale Sources of the Experience Curve Effect

10-10 © 2006 by Nelson, a division of Thomson Canada Limited Product Life Cycle Stages, Industry Price, and Experience Curve Log Cumulative Industry Output, (‘000s) Log Price or Cost per Unit (in constant dollars) and Annual Sales (units) Average Costs Average Industry Prices Annual sales Introduction GrowthShakeoutMaturity

10-11 © 2006 by Nelson, a division of Thomson Canada Limited Pricing Implications of the Experience Curve Log Cumulative Output, Units Log Price or Cost per Unit (in real dollars) Company Costs Industry Price A B C Current Price

10-12 © 2006 by Nelson, a division of Thomson Canada Limited Pricing Strategies for New Products Parity Pricing Price Skimming Penetration Pricing New Product Pricing

10-13 © 2006 by Nelson, a division of Thomson Canada Limited Penetration Pricing Strategic Factors Price Skimming Market factors LargeMarket sizeSmall ElasticElasticity of demandInelastic Product factors LowProduct differentiationHigh LongProduct life spanShort NoProduct protected by a patentYes Price factors YesHigh price will attract competitionNo Customers use higher prices as an indicator of higher qualityYes Cost factors NoSubstantial margins are required to recover product development and other costs Yes Substantial cost reductions are expected due to economies of scaleNo Competitive factors YesLittle chance that competitors will enter market shortly with a similar product No Strategic Factors Influencing the Choice Between Penetration Pricing and Price Skimming

10-14 © 2006 by Nelson, a division of Thomson Canada Limited Pricing Existing Products Prestige Pricing Everyday Low Pricing Cost-plus Pricing Randomized Pricing Value Pricing Promotional Pricing PricingExistingProducts

10-15 © 2006 by Nelson, a division of Thomson Canada Limited Value Pricing 1.Determine target price based on consumer, competitive, and other factors 2.Subtract desired channel intermediary markup 3.Subtract desired manufacturer margin 4.Target cost to be recouped 5.Produce product

10-16 © 2006 by Nelson, a division of Thomson Canada Limited Cost-Plus Pricing 1.Produce product with appropriate features and service level 2.Compute full unit cost 3.Add desired manufacturer margin 4.Add desired channel intermediary margin 5.Retail price

10-17 © 2006 by Nelson, a division of Thomson Canada Limited Product Line Pricing Cross-Subsidization Pricing Two-Part Pricing Price Bundling Product Line Pricing

10-18 © 2006 by Nelson, a division of Thomson Canada Limited Responding to Competitors’ Prices Trigger Pricing Follow-the-Leader Pricing Price Matching Responding to Competitors’ Prices

10-19 © 2006 by Nelson, a division of Thomson Canada Limited Price Customization Strategies Price Customization by Location Price Customization by Customer Price Customization by Time PriceCustomizationStrategies

10-20 © 2006 by Nelson, a division of Thomson Canada Limited Conditions for Price Customization to Work Firm must be able to divide the market into segments with different price sensitivities People must not be able to transfer between segments Different prices must be perceived to be fair by customers

10-21 © 2006 by Nelson, a division of Thomson Canada Limited Price-Profitability Analysis

10-22 © 2006 by Nelson, a division of Thomson Canada Limited Break-Even Analysis Example Assume: Fixed cost = $9,000 Price = $10 Variable Cost = $2 Expected company sales = 1,500 Market size = 5,000 Assume: Fixed cost = $9,000 Price = $10 Variable Cost = $2 Expected company sales = 1,500 Market size = 5,000 Fixed cost $9,000 Break-even (units) = = Price – variable cost $10 - $2 = 1,125 units Fixed cost $9,000 Break-even (units) = = Price – variable cost $10 - $2 = 1,125 units

10-23 © 2006 by Nelson, a division of Thomson Canada Limited Break-Even Market share Break-even unit sales Break-even market share = [ ] × 100 Market size 1,125 = [ ] × 100 5,000 = 22.5 % Break-even unit sales Break-even market share = [ ] × 100 Market size 1,125 = [ ] × 100 5,000 = 22.5 %

10-24 © 2006 by Nelson, a division of Thomson Canada Limited Safety Margin Expected company sales – Break-even unit sales Safety = [ ] × 100 margin Expected company sales 1,500 – 1,125 = [ ] × 100 1,500 = 25 % Expected company sales – Break-even unit sales Safety = [ ] × 100 margin Expected company sales 1,500 – 1,125 = [ ] × 100 1,500 = 25 %

10-25 © 2006 by Nelson, a division of Thomson Canada Limited Break-Even Sales Change Example Assume : Price = $8 Price change = -$1 Contribution margin = $4 Expected company sales = 1,500 Assume : Price = $8 Price change = -$1 Contribution margin = $4 Expected company sales = 1,500

10-26 © 2006 by Nelson, a division of Thomson Canada Limited Break-Even Sales Change Example (c oncluded ) -Price change % Break-even = [ ] × 100 sales change Contribution + Price change margin -(-$1) = [ ] × 100 $4 + (-$1) = 33.3 % Break-even sales change = 0.33 × 1,500 = 500 units -Price change % Break-even = [ ] × 100 sales change Contribution + Price change margin -(-$1) = [ ] × 100 $4 + (-$1) = 33.3 % Break-even sales change = 0.33 × 1,500 = 500 units