Pricing

What this topic is all about

• Pricing strategies, methods and tactics

• Matching price to marketing objectives

• How demand changes in response to changes in price

What is Price?

• The money charged for a product or service

• Everything that a customer has to give up in order to acquire a product or service

• Usually expressed in terms of £

Four views of price

Economists view Price is set by the forces of supply and demand

Accountant’s view

Price should cover costs so that a profit can be made

Customer’s view Price has to represent good value

Marketer’s view Pricing is an opportunity to gain a competitive advantage

Many Factors Affect Price

• Costs of production• Competitors’ prices• Customer perception of

value • The firm’s objectives• Customer demand• Price elasticity of

demand• Target market

• Marketing mix• Stage in the product life

cycle• State of the economy• Expectations of

distributors• State of competition in

the market• Likely reaction from

customers

Setting prices

Stages of price setting

• Develop pricing objectives• Assess of target market’s ability to purchase• Determine demand for product• Analyse demand, cost and profit relationship• Evaluate competitors’ prices• Select pricing strategy & tactics• Decide on price

Some Pricing Objectives

Financial Marketing

Maximise profit

Achieve a target level of profits

Achieve a target rate of return

Maximise sales revenue

Improve cash flow

Maintain/improve market share

Beat/prevent competition

Increase sales

Build a brand

Methods, strategies and tactics

Pricing method The method used to calculate the actual price set

Pricing strategies

Adopted over the medium to long term to achieve marketing objectives Have a significant impact on marketing strategy

Pricing tactics Adopted in the short run to suit particular situations

Limited impact beyond the product itself

PricingMethods

Pricing methods

• Market based pricing– Customer value pricing– Psychological price barrier– Going rate pricing

• Cost based pricing– Full cost pricing– Mark up pricing– Contribution pricing

Market based methods (1)

• Customer perceived value– What customers value the product at– Price is set at an estimate of the product’s value to

customers

• Psychological price barriers– A price beyond which customers will not go– Prices are set based upon the psychological

expectation of customers about price

Market based methods (2)

• Going rate pricing– Price set after taking competitors into account– Method favoured by new entrants to a market

since it avoids price wars– Makes use of the expertise of established firms– But it assumes that competitors set the correct

price and it ignores the fact that firms have different cost bases

Who takes the lead?

Price takers Have no option but to charge the ruling market price

Price makers Able to fix their own price

Price leaders Market leaders whose price changes are followed by rivals

Price followers Follow the price-changing lead of the market leader

Cost plus pricing

• Full cost of making the product plus a % mark up

• Price is set by calculating the full costs (variable/direct plus fixed/indirect cost) of a product and adding a profit margin

• It is relatively easy to calculate the direct costs, but some way has to be devised to allocate the indirect costs

Example of Cost Plus Pricing

Total Costs for producing 10,000 units £100,000

Cost per Unit £10

Add mark-up 100% of cost £10

Selling price = cost + mark-up £20

Factors influencing the mark up %

• Should discounts be offered for bulk purchases?

• Stage in the product life cycle –products at the early stages may need a lower mark up in order to establish demand

• Product : high mark up on slow moving products, low mark up on fast moving products

Advantages of cost plus pricing

• Easy to calculate• Price increases can be justified when costs

rise• Cost increases can be passed onto the

customer• Price stability may arise if competitors take

the same approach• Pricing decisions can be made at a junior

level in a business based on formulas• All costs are covered

Disadvantages of cost plus pricing

• Ignores demand and price elasticity of demand

• May not take account of competition• Profit is missed if price is set below the that

customers are prepared to pay• Lost sales if price is set above the price

customers are willing to pay• Business has less incentive to control costs

Mark up pricing

• % mark up on direct costs• Calculate direct costs and then add an

amount to cover indirect costs• This method is widely used in retailing• Example:

– Buying in price of an item of clothing:£8– Mark up of 200% on buying in price– Selling price £8 plus £16 equals £24

Contribution (marginal) pricing

• Where price is set above the variable costs of production and a contribution is made towards fixed costs and profit

• This is setting a price which covers marginal cost and therefore makes a contribution

• Often used in order to increase capacity utilisation

PricingStrategies

Pricing strategies

• Strategies for new products– Skimming– Penetration

• Strategies for existing products– Price leaders, price followers and price taker– Pre-emptive pricing– Price discrimination

Price Skimming (1)

• Set a high price to maximise profit• Product is sold to different market

segments at different times• Top segment is skimmed off first with the

highest price• Objective

– Maximize profit per unit to achieve quick recovery of development costs

Price Skimming (2)

• Works very well for products that create excitement amongst “early adopters”

• Best used in introduction or early growth stage of product life cycle

• Electronic items provide many great examples

Penetration pricing

• Introduce a new product at a lower price than competitors

• Aim is to– Gain market share quickly– Build customer usage and loyalty

• Opposite of price skimming• Price is raised once target market share is

reached

Prestige pricing

• High price to enhance or reinforce a product’s high quality, luxury image

• Unlike skimming the high price is maintained throughout the life of the product

• Examples : Channel, Bang and Olufsen, Cartier, Lotus

Price quality matrix

High price Medium price

Low price

High quality Premium strategy

Penetration strategy

Superb value

Medium quality

Overcharging strategy

Average strategy

Good value strategy

Low quality Rips off strategy

Cheap,

flashy strategy

Bargain price strategy

Pre-emptive pricing

• Setting prices low to deter new entrants to the market

• This strategy is especially suitable in markets where there are few other barriers to entry

• Pre-emptive pricing should not be confused with predatory pricing

Price discrimination

• Charging different prices to different market segments, based on customer willingness to pay

• Time based discrimination - peak/ off peak pricing used in transport & travel

• Geographic discrimination – e.g. cars are cheaper on mainland Europe than in the UK

• Age discrimination - reductions for the young and the old

PricingTactics

Pricing tactics

• Unlike pricing strategies, these refer to the short run

• Predatory pricing (illegal)• Loss leaders• Psychological pricing• Promotional pricing and discounts

Predatory pricing

• “Predatory pricing occurs when a dominant undertaking incurs losses with the intention of removing a rival and/ or deterring other potential competition” (OFT)

• This anti- competitive practice is used when competitors threaten to reduce market share and profitability

Price wars

• Competitive price reductions by firms in a competitive industry

• Each seeks to increase market share by price reduction but the result is destructive spiral of price reductions

• The process continues until weaker firms go out of business

• Price wars might be seen as good for customers in the short run but it is harmful in the long run if competition is reduced

Psychological pricing

• In this case consideration is given to the psychology of prices and not simply the economics of pricing

• Charging at a price which ends in 99p is a way of deceiving people into believing that the product is cheaper than it really is

Loss leader

• A loss leader is a product prominently displayed and advertised and price below the normal price and even below cost to the seller

• A product which is sold at a low (even loss making) price in order to encourage customers to buy other full price products from the business along with the loss leader product

• Loss leaders are widely used by supermarkets to draw in customers from rival firms

• The aim is to encourage people to buy complementary goods at full price

Promotional pricing and discounts

Type of discount

Who for?

Cash For those who pay cash

Quantity For customers who buy large volumes (bulk buying)

Trade Intermediaries in the trade

Seasonal For buying off peak or out of season

Promotional Temporary pricing of products below list price to increase short run sales

PriceElasticityof Demand

Price Elasticity of Demand

• The demand curve slopes downwards• This means that the quantity demanded falls as price

rises• To increase the quantity sold, it is necessary to reduce

the price• Price elasticity of demand refers to the

responsiveness of demand to changes in price• When demand is elastic, a price rise leads to a more

than proportionate fall off in quantity demanded• When demand is inelastic, a price rise leads to a less

than proportionate fall off in quantity demanded

Elastic demand and sales revenue

• When demand is elastic (responsive to price changes), a rise in price leads to such a fall off in quantity sold that sales revenue falls

• And a price reduction will lead to such a large increase in sales volume that sales revenue rises

• Conclusion : when demand is elastic, price and sales revenue move in opposite directions

Inelastic demand and sales revenue

• When demand is inelastic (not very responsive to price changes), a rise in price will result in only a small reduction in sales volume that sales revenue rises

• And a cut in price produces such a small increase in sales volume that sales revenue falls

• Conclusion: when demand is inelastic price and sales revenue move in the same direction

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Pricing