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Setting the Price

Price is not just a number on a tag of anitem Rent Tuition fees

Medical fees Airline tickets Salary/ Income/ commission Taxes

Prices are sometimes set throughnegotiation between the sellers andbuyers

Reversal of trend Auction

Non-uniform (Nok Air)

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Setting the Price (cont)

Price setting is done in several ways indifferent companies

By the boss

By departments (accounting, production,marketing)

In most cases, a firm must set a price forthe first time when it develops a new

product Introduction into a new or established markets As a key positioning strategy

Defined the expected segment of competitive

market

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Automobile Segment

Segment Examples

Ultimate Rolls-Royce

Gold Standard/ Luxury Mercedes-Benz

Power/ Energy BMW

Safety Volvo

Economy and Fun Honda, FordFamily Toyota

Cosmetics Segment

Segment Examples

Ultimate Channal, DiorCare and Well-being Clinique

Beauty and Fun Stella

Young/ Mass Ponds, Olay

Medical/ Healing Eucerine

Fun/ Mass Mistine

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Price-Quality Strategies

1. Premium

Strategy

2. High-Value

Strategy

5. Medium-ValueStrategy

3. Super-Value

Strategy

4. OverchargingStrategy

7. Rip-OffStrategy

8. False EconomyStrategy

6. Good-ValueStrategy

9. EconomyStrategy

ProductQuality

PriceHigh Medium Low

High

Medium

Low

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Price and Value

Opportunities (orrisk?)

Price = Value

Unharvested Value

Low Medium High

Perceived Value

High

PricePaid

Medium

Low

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SettingthePrice (cont)

Thecompany must setitspriceinrelationtothevalue delivered andperceived bythecustomers

Ifthepriceis higher thanthevalueperceivedopportunity ofprofits orrisksinthe future?

Ifthepriceis lower thanthevalueperceivedmiss opportunityto make moreprofits

To setthe appropriateprice, firm willconsidervarious factorsinpricingpolicy

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1. SelectPricing Objective

2. Determine Demand

3. Estimate Costs

4. Analyze Competitors

5. SelectPricing Methodand FinalPrice

SelectPricing Objectives Decides whereit wantsto

positioninthemarket

Fivemajorpricingobjectives

1) Survival

2) Maximumcurrentprofit

3) MarketPenetration

4) Market skimming

5) Product-qualityleadership

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Pricing Objectives

1. Survival

Facedovercapacity and

intensecompetition

Kee pprices overcosts (variableand fixed)

Sho rt-runobjective

2. Maximize CurrentProfits

Estimatingdemand andcoststo determinethebestpricesthatgivethemostprofits

Assumptions onthose estimations

To e mphasizecurrentperformancemayrisk long-termobjectives

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Pricing Objectives (cont)

3. MarketPenetration

Focus on high salevolumetoresultinlow unitcosts

Long-runprofits

Lowestprice

Assumption onprice sensitivemarket

4. Market Skimming Cha rged highprices for a

selectedgroup of buyers

Assumptions

Sufficientnumber ofbuyers with highdemand

Smallvolume ofproductionispossible(cost factor)

Limitedcompetition

Highpricecommunicates high-qualityimage

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Pricing Objectives (cont)

5. Product-Quality Leader

Focused onrealproduct quality

Cha rged highprices forits worth

Assumptions

Communication ofquality featurestobuyers

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Determine Demand Eachprice willleadto a

differentlevel of demandand have different

impact on acompanysmarketing objectives

Demand Curve showstherelationships betweenpricelevel and demand

Inverserelation

Slopes downward

Slopes upward(prestigegoods)


2. Determine Demand

3. Estimate Costs



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Demand Curve

Quantity (Q)

Price

(P)

100 105

$15

$10

Quantity (Q)

Price

(P)

50 150

$15

$10

(a) Inelastic Demand (b) Elastic Demand

Price Elasticity = % changein Q

% changeinP

Price Elasticity = % changein Q

% changeinP

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Price Sensitivity

The demandcurve showstheprobablepurchasing quantity at alternativeprices

Price-sensitive buyers aremore

influenced bypricechanges A small priceincreaseleadsto a biggerdecreasein quantity demanded elasticdemand

A small priceincreaseleadsto a smallerdecreasein quantity demanded inelasticdemand

Whichtype ofcustomers do firmsprefer?

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Price Sensitivity (cont)

The h igherthe elasticity, thegreaterthevolumegrowth with 1% pricereduction

Demandislikelyto beless elastic: The re are few substitutes/competitors

Buyers donotreadilynoticepriceincreases Buyers are slowtochangetheir buying habits

Buyersthink that higherprices are justified

Whe n demandis elastic, producers willtendto

lowerthepricetoraise salesvolume

higherrevenue

How aboutinelastic demand?

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Price Sensitivity (cont)

Considering discountcoupons;

Who arethecompaniestargeting? Purposes forthecompanies of buyers using and

not-usingthecoupons

Why not have discounts for all buyers?

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Estimate Costs A companyscoststake 2forms

Fixed Donotvary with

production Egrent, interest, salary

Variable

Vary directly withproduction or salesrevenue

Egrawmaterials,packaging

Total Costs = Fixed Costs +Variable Costs

Average Costs = Costper

unit ofproduction


2. Determine Demand

3. Estimate Costs



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Costs

Economies of Scale Spreadingthe fixedcost asproduction

volumeincreases

Averagecost (unitcosts) falls TotalCosts = FixedCost + VariableCosts

AverageCosts = FixedCost + VariableCosts

Unit Unit

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COST ANALYSIS

Rent ($) Material/ Unit ($) Unit Total Cost ($) Average Cost ($)

10,000 10 0 10,000 #DIV/0!

10,000 10 100 11,000 110.0

10,000 10 200 12,000 60.0

10,000 10 300 13,000 43.3

10,000 10 400 14,000 35.0

10,000 10 500 15,000 30.0

10,000 10 600 16,000 26.7

10,000 10 700 17,000 24.3

10,000 10 800 18,000 22.5

10,000 10 900 19,000 21.110,000 10 1000 20,000 20.0

10,000 10 1100 21,000 19.1

10,000 10 1200 22,000 18.3

10,000 10 1300 23,000 17.7

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Total ost ($)

0

5,000

10,000

15,000

20,000

25,000

Unit 0 100 200 300 400 500 600 700 800 900 1000 1100 1200

Total ost ($)

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Aver age Cost ($)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

Unit 0 100 200 300 400 500 600 700 800 900 1000 1100 1200

Average Cost ($)

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AnalyzeCompetitors

Gives an overview ofthemarket

Takesintoconsiderationcosts, prices, features andpossiblereactions fromcompetitors

Possiblepositioning:price higher, lower orthesame ascompetitors


2. Determine Demand

3. EstimateCosts

4. AnalyzeCompetitors



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SelectPricing Methodand FinalPrice

1) MarkupPricing

2) Target-ReturnPricing3) Perceived Value-Pricing

4) ValuePricing

5) Going-RatePricing

6) Auction-TypePricing English

Dutch

Sealed-Bid


2. Determine Demand

3. EstimateCosts

4. AnalyzeCompetitors



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1. MarkupPrice Setprice based oncosts and expectedprofit

Example

When unitcost = $60 andthecompany expects20% return, MarkupPrice = $60 / (1-0.2) = $75

(note:notthe same as $60 x 1.2 = $72)

Pricing Methods

MarkupPrice = UnitCost

( 1 Desired Return)

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1. MarkupPrice (cont) Easyto use

Logicalto ensurethat allcosts arecovered

Prices withinthe sameindustry willtendto

become similar (if havethe samecosts) lesspricecompetition

Justifiedtothe buyers (andthe sellers)

Doesthe use of standardmarkups always

makelogical sense? Ignore demand, perceivedvalue and

competition

Assumesthatthemarkupprices bringsinexpectedlevel of sales

Pricing Methods (cont)

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2. Target-ReturnPricing Price yieldstargetreturn oninvestment (ROI)

Usually used for firms withlarge fixedcapital ofinvestment eg automobile, utilities

Example: A toastermanufacturer hasinvested $1millioninthe business and wantsto earn 20% ROI.Expecting 50,000 units sales, targetprice for each

toasteris;= unitcost + ROI x InvestmentCapitalUnit Sale

= $16 + 20% x $1million = $20

50,000


Assumptions?

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2. Target-ReturnPricing (cont) To ensurethatpricecoverscosts atcertainlevel,

Breakeven Analysiscan be used

Withtotal fixedcosts of $300,000, sellingprice at$20 andvariablecosts at $10, thevolumerequiredto breakevenis = $300,000 = 30,000 units

($20 - $10)

What happento breakevenvolumeif fixedcostsincrease?

Ifprice decreases?


Breakeven Volume = FixedCost

(Price VariableCosts)

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3. Perceived-ValuePricing Base onthepromisedvalue deliveredto

customers

Perceivedvalueismade up of several elements

Image, warranty, performance, reputation,buyingconvenience

Buyersplace different emphasis on differentvalue elements

Price buyers:must keeppriceslow; offerthebasics

Value buyers: keepinnovatingnewproductsand aggressively affirmtheirvalue

Loyal buyers: investinrelationship building and

customerintimacy


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3. Perceived-ValuePricing (cont) Doesnot base onmanufacturingcoststo set

price

Add orreduceprice accordingtothevalueelements offered


Sony TVPrice Value

$90 Similartocompetitor (baseprice)

$7 Sonys TV durability

$6 Sonys TVreliability

$5 Sonys superior service

$2 Sonys warranty onparts

-$1 Discount

$100 FinalPrice

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4. ValuePricing The aimis keepcostslowtochargelowprices

Different from offering discount /promotionalprices

Everyday LowPricing

Long-term strategy

Involvesre-engineering operations (internal andexternal) toresultsin efficiency lowcosts

5. Going-RatePricing Bases oncompetitors Followtheleader

EgPetrol


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6. Auction-TypePricing Popular ontheinternet and electronicmarketplaces

Common for disposing excessinventories or usedgoods


1. English Auction (Ascending)- Bidderraiseprices untilthe highest priceisreached

2. Dutch Auction (Descending)- One seller, many buyers

Auctioneer announces a highprice and slowly decreasesthepricetilla bidder accepts

- One buyer, many sellers The buyer announces something he wants and sellerscompeteto

offerthelowestprice

3. Sea led-Bid Auction

- Seller submit aclosed offerto bid

Auction Type

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AdaptingthePrice

Companies usually donot set a singleprice Set apricing structurethat reflects

variationsin: Geographical demand andcosts

Market segmentrequirements Purchasetiming

Orderlevels

Delivery frequency

Servicecontracts With discounts, allowances and

promotional supports, companiesrarelyrealizethe samelevel ofprofit from each

unit ofproduct

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AdaptingthePrice (cont)

Product-Mix Pricing Price-settinglogicmust bemodified whenthe

productispart of aproductline

Firm will searchto setpricesthatmaximizeprofits ofthetotalproductmix

Wecan distinguish6 situationsinvolvingproduct-mix pricing

Product-linepricing, Optional-featurepricing, captive-productpricing, Tow-partpricing, By-productpricing andProduct-bundlingpricing

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Product-Mix Pricing (cont)

5. By-ProductPricing Some by-products have

valuetocertainconsumergroups andshould bepriced ontheir

value Income earned onthe by-

products allowmanufacturerstochargelowerprices onthemain

products Eg Meat andmeatparts, Wood and sawdust, Petroleum andchemicalproducts

6. Product-BundlingPricing

Pure Bundling: Productsare offeredin bundles only

Whole-daypreschoolnursery

Mixed Bundling: Sellersoffergoodsindividually aswell asin bundles

Price ofgoodsinpacksarelowerthatif boughtseparately

Eg Hotelpackages

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Initiating and RespondingtoPriceChanges

InitiatingPriceCutsReasons

Excessplantcapacity

Needtogetmore sales and business

To dominatemarketthroughlowercosts

ConsequencesLow-Quality Trap:Consumersmight

assumethatthe qualityislow

Fragile-Market-Share: Lowpricemay buymarket share butnotloyalty

Price War: Others will follow and firmsthat havethe deeperpockets survive

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Initiating and RespondingtoPriceChanges (cont)

Informationneeded for apricechange Customers ability & willingness

to buy; customerlifestyle;benefits sought; characteristics oftheproduct e.g.

Whenthe kopitiams, localcoffeeshopsin Singaporetriedtoraisetheprice of acup ofcoffee by10centsin March1994, thegrass-

rootreaction was stormyWhen StarbucksCoffee and

Spinellisraisedtheirpricesinthebeginning of1998 by a hefty 20%,nobodyraised an eyelit

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Three strategic alternatives:

Maintainthepriceif you aretheleader

In1999, Shellin Singaporemaintaineditspricewhen otherpetrolcompanies engagedin aprice

war untiltowardsthe end ofthe engagement Reducetheprice

SIA regularlyreduceits airfarein anticipation ofthe developingmarket situations

Increasetheprice

Duringinflation, orif demandis expectedtoincrease orif you wishto harvest

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InitiatingPrice Increases Reasons

Toraiseprofits (assumingthegain fromhigherprices exceedsthe fallinvolume ofsales units)

Tocoverrisingcosts

Tocontrol over-demand whenthecompanycannot supply enough

Consequences

Delayed quotationpricing:company doesnot setthe finalprice early

Unbundling:Companymaintainsthepricebutremove somecomponents or services

Reduction of discounts

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InitiatingPrice Increases (cont) Companiescanrespondtotherisingcosts or

demand withoutraisingprices

Shrink product amount

Substitute withless expensivematerialparts oringredients

Reduce orremovecertain services orproduct features

Useless expensivepackagingSell fewermodels/productlines orinlarger

bulks

Createnew economy brands

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PriceChanges

Customer Reactions

Questionthemotivation behindthepricechanges

Products areaboutto bereplaced?

Theitems arefaulty ornotselling well?

The quality hasbeenreduced?

Competitor Reactions

Treats eachpricechange as a freshchallenge andreact

accordinglyto self-interest atthetime

Searchcurrentfinancial situation,recent sales,

customerloyalty,market share

Differentcompetitorshave differentinterpretations on a

pricechange

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RespondingtoCompetitors PriceChanges

Inmarketscharacterized by homogeneousproducts, firms will keepprices stable and anypricechange will be brought back tonormallevel withtime

Collectivepricechange will followifitimprovetheindustry as a whole

Inmarkets wheregoods are differentiated,players will havetoconsidermany factorstodecide onthemoves

Whypricecut?, Willit betemporary?, Whathappenstomarket share?, How are othercompaniesgoingtorespond?

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RespondingtoCompetitors PriceChanges (cont)

Marketleaders frequently faceaggressivepricecutting by smaller firmstryingto buildmarket share

Theycanrespondin several ways

Maintainprice: Remaincalm, hoping forstablemarket situation (profits andmarketshare)

Maintainprice and addvalue

Reduceprice: expect high sales and fallingcosts (economies of scale)

Increaseprice andimprove quality

Launch alow-price fighterline

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RespondingtoCompetitors PriceChanges (cont)

The bestresponsevaries withthesituation

Products LifeCycle

Importancetocompanyportfolio Competitors intention

Ownresources

Markets sensitivitytoprice and

quality

Behavior ofcosts with salesvolume

Alternative options

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A Price ReactionProgram

Hascompetitorcut hisprice?

Hold ourprice andcontinueto watchcompetitorsprice

Isthepricelikelyto hurt our sales

significantly?

Isitlikelyto bepermanentprice

cut?

Howmuchisthepricecut?

Lessthan 2%Introduce

discountcoupon

By 2-4% Dropprice by half of

thepricecut

Morethan 4%Droppriceto

matchcompetitor

No

Yes

YesNo No

Yes

Documents

MM (Chapter16)