2. Pricing Strategy Elisa Montaguti Warwick Business School

3. Price: What do you want to get out of it?? Survival Current profit Revenues Sales Growth Market Skimming Product quality leadership

4. Elisa Montaguti Warwick Business School Suppose that your company has just developed a computer chip for personal computers that has a faster processing speed than any other computer chip currently on the market. How would you decide what the ‘perfect price’ is for this chip?

5. Elisa Montaguti Warwick Business School Price ceiling the most that customers would pay Price floor the minimum you can afford

6. Elisa Montaguti Warwick Business School Impact of Poor Price Decisions Price too low? Costs and/or investments are not covered Profit not maximised Overheated capacity trying to meet demand Brand image negatively affected Price too high? Potential market share not maximised Inventory holding costs if too few sold Brand image negatively affected

7. Elisa Montaguti Warwick Business School Issues for this Session Issues for this Session Why business goals usually solve only part of the pricing problem Why economics usually solve only part of the pricing problem How customer-focused pricing can solve other part of the problem

8. Elisa Montaguti Warwick Business School Pricing from the ‘Floor’ These methods choose price based on costs and desired profitability Markup pricing: add margins based on the desired overall profit Target return: add margins based on desired return on investment.

9. Elisa Montaguti Warwick Business School Photodigital Digital Cameras Variable cost: £ 5.5 (e.g. raw materials, labour, shipping, packaging) Fixed costs:£ 250,000 (e.g. advertising, PR) Invested capital: £ 1 m (e.g. R&D, project management salaries)

10. Elisa Montaguti Warwick Business School “Markup pricing” The company is expecting 100,000 units and wants a 20 % return on sales (considers investment a sunk cost) unit cost= var cost+fixed cost distributed over number of units unit cost= 5.5 + (250,00/100,000) = £ 8 markup price= £ 8/0.8 = £ 10

11. Elisa Montaguti Warwick Business School “Markup pricing”: what if sales went up? The company is expecting 150,000 units unit cost= var cost+fixed cost distributed over number of units unit cost= 5.5 + (250,00/150,000) = £ 7.17 markup price= £ 7.17/0.8 = £ 8.96 (down from £10)

12. Elisa Montaguti Warwick Business School “Markup pricing”: what if sales went down? The company is expecting 75,000 units unit cost= var cost+fixed cost distributed over number of units unit cost= 5.5 + (250,00/75,000) = £ 8.83 markup price= £ 8.83/0.8 = £ 11.04 (up from £10)

13. Elisa Montaguti Warwick Business School Therefore... Target return and markup pricing do not inherently take market behaviour or consumer needs/wants into account The result is a pricing strategy that is based on desired value for the producer, not perceived value for the customer Costs are important, but customers can not be ignored

14. Elisa Montaguti Warwick Business School Price Elasticity: How much does volume change when price changes? X 2 X 1 o o p2p1p2p1 p2p1p2p1

15. Elisa Montaguti Warwick Business School Price: Demand, Cost and profit o £ Q Marginal revenue Average revenue Average cost Marginal cost

16. Elisa Montaguti Warwick Business School Price: Break even point o £ Units of production Fixed costs Fixed costs Losses Break even point Total revenue Profits Total variable costs Total costs

17. Pricing: the Impact of Advertising Elisa Montaguti Warwick Business School X 2 X 1 o o p2p1p2p1 p2p1p2p1 A Software Unsupported by a Strong Advertising Campaign The Same Software Supported by a Strong Advertising Campaign a Strong Advertising Campaign

18. Elisa Montaguti Warwick Business School Price Discrimination Selling products to different customers at different net prices When: Market can be separated “perfectly sealed” no resale (transferability) Customers must be sorted (segmentation) Different “intensity/elasticities” across customers Seller must have some monopoly power

19. Let’s consider the Danieli Hotel in Venice. It’s variable costs are £ 10 per room It’s variable costs are £ 10 per room Each of the 4 different segments is willing to pay Each of the 4 different segments is willing to pay the following amount per room: Segment A (students) £ 30 Segment B (elderly people)£ 60 Segment C (tourists)£ 90 Segment D (business men)£ 120 Elisa Montaguti Warwick Business School Price Discrimination: How does it work?

20. The Danieli Hotel could choose a price equal to £30  = 4N(30-10) = 80 Or equal to £60  = 3N(60-10) = 150 Or equal to £90  = 2N(90-10) = 160 Or equal to £120  = 1N(120-10) = 110 Elisa Montaguti Warwick Business School Price Discrimination: How does it work? (2)

21. Elisa Montaguti Warwick Business School Price Discrimination: How does it work? (2) Or: N(120-10)+ 2N(90-10)+ 3N(60-10)+ 4N(30-10) =£.(110+160+150+20)N=440N

22. Expected non Searcher quantity Expected non Searcher quantity p= the fraction of the time the shirts are priced at $50. Price Discrimination:An Example p p=$30 p=$50 Expected Searcher Quantity Total Contribution 0.0 0.10 0.79 0.80 0.81 0.82 0.83 0.85 0.90 1.00 100 90 21 20 19 18 17 15 10 0 10 79 80 81 82 83 85 90 100 100.0 99.9 50.7 48.8 46.9 44.9 42.8 38.6 27.1 0.0 $ 2,000 2,199 3,087 3,088 3,089 3,088 3,086 3,071 $ 3,000

23. Price Discrimination:When Product line pricing Follow on products Bundling

24. Mach3 Price: $ 6.99 Cartridge: $ 5.99

25. Elisa Montaguti Warwick Business School Price Discrimination:Risks 1- It is not easy to know reservation price,..it might not be a good idea to ask 2-Prices are often known 3- It is difficult to avoid arbitrage 4-The customers ….could get upset!!

26. Demand functions are useful for getting a general idea of the potential upside or risk of a price increase or decrease, but other considerations must be taken into account Choosing price using a demand function

27. Elisa Montaguti Warwick Business School Price and competition When changing your cost or price structure, be sure to gauge carefully the potential impact on competition Options: going-rate pricing going-rate pricing sealed-bid pricing sealed-bid pricing Risk: Risk: Price War Price War

28. Elisa Montaguti Warwick Business School Price and customer’s overall value It is important to take into account costs and risks, but this does not substitute for taking customer preferences and needs into account as well.

29. When asked whether they were “well informed” on six of the potential inputs to the product pricing decision, managers at one of well respected U.S.-based multinational responded as follows: 84 % were well informed on the variable cost 81 % were well informed on the fixed cost 75 % were well informed on the price of competitors 61 % were well informed on the value of their products 34 % were well informed on how consumers respond to price changes 21 % were well informed on consumer’s willingness to pay

30. You are lying on the beach on a hot day. All you have to drink is ice water. For the past hour, you have been thinking about how much you would enjoy a nice cold bottle of your favourite beer. A friend gets up to make a phone call and offers To bring back a bottle of your favourite beer from the only nearby place where the beer is sold – a small, run down-grocery store. He says that the beer might be expensive and asks how much you are willing to spend. He says that the beer might be expensive and asks how much are you willing to spend. He says he will not buy the beer if it costs more than the price you state. What price do you tell your friend?

31. You are lying on the beach on a hot day. All you have to drink is ice water. For the past hour, you have been thinking about how much you would enjoy a nice cold bottle of your favourite beer. A friend gets up to make a phone call and offers To bring back a bottle of your favourite beer from the only nearby place where the beer is sold – a fancy resort hotel. He says that the beer might be expensive and asks how much you are willing to spend. He says that the beer might be expensive and asks how much are you willing to spend. He says he will not buy the beer if it costs more than the price you state. What price do you tell your friend?

32. Consumer Willingness to Pay Economic Utility of the Transaction Fairness of the transaction =+ Perceived Value –Actual Price [(Perceived Value-Actual)/(Actual Price)] [Actual Price-Expected or Reference Price] [Actual Price-Cost of Goods Sold]

33. Elisa Montaguti Warwick Business School Finally…let’s choose a price! Price Ceiling Influenced by customer’s total available income and habitual spending patterns in the product area (price elasticity helpful here) Price Floor Influenced by provider’s cost structure and minimum/maximum value placed on winning customers in this market (cost helpful here) Customer perception of competitive options Customer perception of value of value

34. Elisa Montaguti Warwick Business School What did we learn?... Cost-plus pricing provides one perspective on remaining in Cost-plus pricing provides one perspective on remaining in business, but leaves the customer out of the picture Price elasticity offers a global estimate of risk, but is only a rough Price elasticity offers a global estimate of risk, but is only a rough estimate and it is sensitive to other marketing variables There is often quite a lot of room between the price ceiling and There is often quite a lot of room between the price ceiling and the price floor, and it is this area over which marketing has the most influence