1. 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

2. Steps in the Price Planning Process

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

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

5. 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

6. 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

7. 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.

8. 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)

9. 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

10. 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.

11. 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.)

12. 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

13. 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)

14. 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

15. 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)

16. 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

17. 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.

18. 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

19. 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

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

21. 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

22. “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
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.

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

24. 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

25. 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)

26. 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”

27. 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

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