Professor Chip Besio Cox School of Business Southern Methodist University

Pricing Considerations  Objectives: Enhance brand image Provide customer value Obtain an adequate ROI Maximize profits Maintain price stability in an industry or market

Factors Affecting Pricing Internal Factors Costs Product, Strategy Internal Factors Costs Product, Strategy Pricing Decisions Pricing Decisions External Factors Competitors Customers External Factors Competitors Customers

Pricing Considerations  Factors Effecting Pricing: Demand sets price ceiling Cost sets price floor Consumer value perceptions Consumer price sensitivity Government regulations

Pricing Considerations  Factors Effecting Pricing: Product/Service differentiation Organization’s financial goals Stage of Product Life Cycle Marketing Channel margin impact Prices of other products in mix

Customer Considerations PRICE SENSITIVITY  Product categories are not uniformly responsive to prices -- some are more sensitive to price levels than others  Customers also may respond differently than one another to price levels Price sensitivity (price elasticity) reflects how purchase behavior changes with changes in price

Pricing Considerations PRICE SENSITIVITY Price Quantity Demanded per Period A. Inelastic Demand - Demand hardly changes with a small change in price P2P2 P1P1 Q1Q1 Q2Q2 Price Quantity Demanded per Period P2P2 P1P1 Q1Q1 Q2Q2 B. Elastic Demand - Demand changes greatly with a small change in price

Product-Based Pricing Approaches Product Line Pricing Setting price steps between product line items i.e. $299, $399 Product Line Pricing Setting price steps between product line items i.e. $299, $399 Optional-Product Pricing Pricing optional or accessory products sold with the main product *** i.e. car options Optional-Product Pricing Pricing optional or accessory products sold with the main product *** i.e. car options Captive-Product Pricing Pricing products that must be used with the main Product***i.e. Razor Blades, Film, Software Captive-Product Pricing Pricing products that must be used with the main Product***i.e. Razor Blades, Film, Software By-Product Pricing Pricing low-value by-products to get rid of them ***i.e. Lumber Mills, Zoos By-Product Pricing Pricing low-value by-products to get rid of them ***i.e. Lumber Mills, Zoos Product-Bundle Pricing Pricing bundles Of products sold together ***i.e. season tickets, computer makers Product-Bundle Pricing Pricing bundles Of products sold together ***i.e. season tickets, computer makers Source: Prentice Hall

Cost Considerations  Recall that costs may depend on the production level Total Costs Sum of the Fixed and Variable Costs for a Given Level of Production Total Costs Sum of the Fixed and Variable Costs for a Given Level of Production Fixed Costs (Overhead) Costs that don’t vary with sales or production levels. Executive Salaries Rent Variable Costs Costs that do vary directly with the level of production. Raw materials

Cost Based Pricing Strategies  Full Cost Strategies  Variable Cost Strategies  New-Offering Strategies  Competitive Bidding

Cost Based Pricing Strategies  Full Cost Strategies Markup Pricing Break-even Pricing ROR Pricing

Cost Based Pricing Strategies  Variable Cost Strategies Stimulate Demand Shift Demand

Cost-Based Pricing Approaches  Cost-Plus Pricing  Cost-Plus Pricing - Adds a standard mark up to the cost of the product Useful when there are a great many products or demand is hard to forecast Simple to implement  Breakeven or Target Profit Pricing  Breakeven or Target Profit Pricing - Price is set to meet a specific profit target Also takes consumer demand into account

Cost-Based Pricing COST-PLUS Minimizes price competition Minimizes price competition Perceived fairness for both buyers and sellers Perceived fairness for both buyers and sellers Sellers are more certain about costs than demand Sellers are more certain about costs than demand

Pricing Strategies  Competitive Bidding Demand is Known & Constant Marketing Mix Variables Uncontrollable Sophisticated Mathematical Models ○ Calculate Profit Levels ○ Calculate Probability of Winning at Different Price Levels

Cost Based Pricing Strategies  New-Offering Strategies Skimming Penetration Intermediate

New Product Intro Strategies  Capture “cream” – less price sensitive buyers  High Profit Margin – sacrifice volume  Invite Competitors, Short-term Profits  Sell Whole Market – no “elite” market  High Volume – sacrifice profit margin  Keep Competition Out – B.O.E. INTENT FOCUS RESULT SKIMMING PENETRATION

New Product Intro Strategies  Skimming Strategy Price High Initially Reduce Over Time Inelastic Demand - Buyers Price Range Unique Offering

New Product Intro Strategies  Skimming Strategy Production or Marketing Costs Unknown Limited Capacity to Deliver Realistic Perceived Value

New Product Intro Strategies  Penetration Strategy Price Low Initially Elastic Demand Offering Not Unique Competition Entering Quickly

New Product Intro Strategies  Penetration Strategy No Distinct Price Segments Volume Increases Dramatically Impact Costs Objective - Large Market Share

New Product Intro Strategies  Intermediate Strategy More Prevalent Less Dramatic

Pricing Strategies  Experience Curve Pricing below cost in short-term ○ Build volume thus lowering costs Costs decline because ○ Learning by labor ○ Labor specialization ○ New process adoption ○ Product re-design ○ Materials substitution ○ Ability to spread fixed costs

Pricing Strategies  Experience Curve Advantages could be mitigated by ○ Technology innovation – competitor ○ Key patent control – competitor ○ Material-supply limitations ○ Government regulations

Pricing Strategies

 Competitive Bidding Demand is Known & Constant Marketing Mix Variables Uncontrollable Sophisticated Mathematical Models ○ Calculate Profit Levels ○ Calculate Probability of Winning at Different Price Levels

Customer Considerations PRICE AS A SIGNAL  Price not only has the traditional economic role of negatively affecting demand but also offers the customer information about product quality  When is price used as a signal? When there is little information about product quality available Primarily for experience or credence goods

Customer Considerations VALUE PRICING Product Cost Price Value Customers Customer Value Price Cost Product Cost-Based Pricing Value-Based Pricing

General Price Adjustment Strategies Adjusting Prices for Psychological Effect. Price Used as a Signal Temporarily Reducing Prices to Increase Short-Run Sales. i.e. Loss Leaders, Special-Events Adjusting Prices to Account for the Geographic Location of Customers. i.e. FOB-Origin, Uniform-Delivered, Zone Pricing, Basing-Point, & Freight-Absorption. Adjusting Prices for International Markets. Price Depends on Costs, Consumers, Economic Conditions & Other Factors. Psychological Pricing Promotional Pricing Geographical Pricing International Pricing