Pricing Techniques and Analysis ( Continued from before) Pertemuan Pricing Techniques and Analysis ( Continued from before) Matakuliah: J0434 / Ekonomi Managerial Tahun: 01 September 2005 Versi: revisi

Learning Outcomes Pada akhir pertemuan ini, diharapkan mahasiswa akan mampu : Membuat analisis teknik penetapan harga ( C4)

Outline Materi Pricing In Segmented Markets Pricing of Multiple Product Substitutes & Complements Pricing of Joint Products

 2002 South-Western Publishing Value-based more than cost-based pricing often helps build profits. Firms charge different customers different prices, which is known as price discrimination. This chapter also looks at pricing within a firm called transfer pricing. Pricing techniques that are used by many multi- product firms, such as full-cost pricing and target return pricing. Pricing Techniques and Analysis

Pricing In Segmented Markets Segment markets by price sensitivity Charge higher prices in the markets that are the most inelastic Then P 1 = $150 and P 2 = $120 P ( 1 + 1/ E QP ) = MC Suppose MC = $100 in 2 markets and E 1 = - 3 and E 2 = - 6 Why are haircuts for kids cheaper than for adults?

Products are INDEPENDENT when changes in price and quantity of one product do not alter revenues or cost in the others Products are INTERDEPENDENT, when changes DO affect other products Ex: Procter & Gamble makes both Luvs and Pampers –TR = TR A + TR B Pricing of Multiple Product

Substitutes & Complements Look for interdependencies in marginal revenues: –MR A =  TR A /  Q A +  TR B /  Q A –MR B =  TR A /  Q B +  TR B /  Q B Substitutes when cross terms are negative –Erosion or Cannibalism are terms used Complements when cross terms are positive –BASE sells tapes and tape head cleaners

Decision Rule for Multiple Product Firms Do NOT use the rule to produce where MR=MC, as in MR A = MC A INSTEAD: – Produce where the FULL MR = FULL MC –For a Two Product Firm of A & B –Produce where:  TR A /  Q A +  TR B /  Q A =  TC A /  Q A +  TC B /  Q A Include all relevant revenue and cost effects

Pricing Example in Supermarkets Turkey prices fall during Thanksgiving –Yet we would expect DEMAND to be greatest?! Loss Leader Pricing –Consider T as turkey –and A as all other food TR store = TR T + TR A MR store for turkey =  TR T /  Q T +  TR A /  Q T Complementarity with other food explains the apparent conundrum

Pricing of Joint Products Interdependencies in costs occur in products that are produced simultaneously Excess means the price would be ZERO The solution is to hold back some of the excess to reach the Unit Elastic Point on the Demand Curve. This Maximizes Total Revenue.

Multi-Divisional Firms and the Economics of Transfer Pricing Transfer Pricing serves two functions: 1.Measure of the marginal value of the resource 2.Provides a performance measures of resources used For international firms, transfer pricing may assist in reducing worldwide taxation, but the ability to reduce taxation is limited because the IRS requires arm’s length prices.

Create Transfer Prices Similar to Competitive Market Prices Disagreements across divisions are common –“Selling” Division wants a HIGH transfer price –“Buying” Division wants a LOW transfer price When External Markets exists, use those prices for transfer (a market-based competitive price) motor assembly final car assembly sell to “P” purchase motors from “P”

Transfer Pricing With No External Markets When no external markets exist, use the MC of the transferred good. Often, however, the MC is a function of output. Marketing and Production steps (M & P) Transfer price is P T = MC P on following figure

Find Where MC M+P = MR D MC M MC P MC M+P MR P PTPT

Pricing in Practice In practice, pricing strategy involves the whole life-cycle of the product. Managers report wide use of cost- plus pricing methods because it: –Streamlines pricing of multiple products –Streamlines pricing of retail prices

Cost-Plus and Full Cost Pricing P = AC n + Markup or P = AC n (1 + m) where AC n is average cost at a normal output and m is a percentage markup Notice: Little reliance on MC pricing or use of elasticities, as in: P( 1 + 1/E p ) = MC

Cost-Plus Pricing : Illustrated Manufacturing pricing illustrated: One Good AFC AVC QnQn Q capacity AC n } markup P ATC

Cost-Plus Pricing : Illustrated AFC AVC QnQn Q capacity AC n } markup P D 1 D 2 quantity varies as demand varies

Cost-Plus Pricing : Illustrated AFC AVC QnQn Q capacity AC n } markup P D 1 D 2 quantity varies as demand varies Q1Q1 Q2Q2

Full Cost Pricing Full Cost- - –Covers all Costs at the standard or normal output –Plus a return on the investment P = AFC n + AVC n +  K / Q n –where  K is the target amount of profit –and  is the desired profit rate and K is gross operating assets Example: Low Tech Security FC = 200,000, Q n = 3000, VC = 90,000  = 20% and K=$500,000. Find Full Cost Price!

Full Cost Pricing Answer –P = AVC + AFC + (.20)(500,000)/Q –P = = $130 Also, suppose a 35% markup on cost –P = [ AC n ] (1.35) –P = [ ](1.35) –P = $130.50

Advantages Cost-plus is simple It is easy to delegate to others Easy to apply to thousands of items –Can use categories of markups for different classes of products Disadvantages But cost-plus ignores demand changes Pricing may be based on poor cost data Output varies in business cycle Hybrid Method: Variable Cost-Plus Pricing -- the markup can vary over the season or business cycle Cost-Plus Pricing

 1999 South-Western College Publishing Optimal Markups in Practice Grocery stores have low markups Many close substitutes -- at other grocery stores (bread varieties and qualities are standardized) Frequent purchase, so customers are knowledgeable about prices & quality Demand is therefore highly elastic Optimal markup would consequently be small

 1999 South-Western College Publishing Markups on Jewelry Jewelry Markups are known to be large Difficult to make comparisons across jewelry stores Little repeat purchases, so knowledge about prices is low Consequently, lower price elasticity for jewelry The optimal markup is larger

 1999 South-Western College Publishing Skimming a form of block rate pricing over time Price declines over time Those who wish to get it first pays the highest price, others are willing to wait Examples: –Hardcover & Paperback Books –New electrical & Computer Products TIME P D

Revenue Management: Revenue Management is the problem of the disappearing inventory. Managers must be flexible to change their predicted sales by market segment as information arrives. Airlines price discriminates between business and non-business travelers. If too few business travelers have booked tickets compared to the amount expected, then more non-business tickets should be released.

Optimal Overbooking Managers may authorize reservation clerks to sell more seats (rooms) than are available. The greater the overbooking, the lower are the costs of spoilage. Spoilage is an inventory NOT sold. If capacity is large, an airline or hotel will have high spoilage. The greater the overbooking, the greater are the costs of spillage, making customers unhappy by finding that they have no seat or reservation.

Spillage Spillage is the excess demand that cannot be met. If the service industry has low capacity, the spillage will be great Customers leave the hotel or airline unable to get a room or an airplane seat.

Optimal Overbooking Spillage and spoilage costs go in opposite directions, the sum of these costs has a minimum with the optimal amount of overbooking. Since business travelers tend to a large extent to be repeat customers, the cost of spillage (oversells) may be very high. The optimal amount of overbooking for this market segment may well be lower than for non-business clients. 100% 110% 120%... Percent Overbooked Spoilage Spillage Total Cost optimal