Download Pricing Decisions Market based pricing strategies

Pricing Decisions
Management Level – Paper P2
Advanced Management Accounting
Lecture - 25
Vidya Rajawasam
ACMA CGMA MBA
Pricing Decisions
In the previous lectures we have
discussed
 Pricing strategies based on cost
 Marginal cost plus pricing
 Market based pricing strategies
Pricing Decisions
In this lecture we will discuss
 Market based pricing strategies
Pricing Decisions
Market based pricing strategies
Market skimming
Skimming is a technique where a high
price is set for the product initially, so that
only those who are desperately keen on
the product will buy it. Then the price is
lowered, making the product more
accessible.
Pricing Decisions
Market based pricing strategies
Market skimming
When the next group of customers have
had a chance to buy at that price, the price
is lowered again, and so on. The aim of
this strategy is usually to maximize
revenue.
But, on occasions, it is also used to prolong
the life of older products.
Pricing Decisions
Market based pricing strategies
Market skimming
Consumer durable companies tend to skim
the market. This is done, to a certain
extent, to recover large research and
development costs quite quickly.
But the products also lend themselves to
this treatment as trend-setters are willing to
pay a high price to own the latest gismo,
and the rest of the population follow their
example in later years.
Pricing Decisions
Market based pricing strategies
Market skimming
Books are also sold this way, with new
novels published in hardback at a high
price. The hard cover costs little more than
a soft cover. Avid readers of that author will
buy the hardback book at the high price.
A year or so later the book is reissued with
a soft cover at a much cheaper price in
order to reach a wider audience.
Pricing Decisions
Market based pricing strategies
Market skimming
Price skimming was probably first
employed at the end of the eighteenth
century by Josiah Wedgwood, the famous
ceramics manufacturer. He made classicalshaped vases decorated with sprigs of
decoration, which he sold to the rich and
well-to-do.
Naturally he priced his products
accordingly.
Pricing Decisions
Market based pricing strategies
Market skimming
As the designs became old and well known
he reduced the price on those lines and
introduced new designs at the high price.
Thus, he created different tiers of markets for
his products, and people who were not so
well off could afford a piece which had been
in production for some years.
This marketing technique helps to prolong a
product’s life and extracts the maximum profit
from it.
Pricing Decisions
Market based pricing strategies
Market skimming
If demand for a new or innovative product is
relatively inelastic the supplier has the
chance of adopting a market skimming price
strategy.
It is usually much easier to reduce prices than
increase them, so it is better to begin with a
high price, and lower it if demand appears
more elastic than anticipated.
Pricing Decisions
Market based pricing strategies
Market skimming
If profitable skimming is to be sustained
beyond the introductory phase, there must be
significant barriers to entry to the market, in
order to deter too many potential competitors
entering attracted by the high prices and
returns.
Pricing Decisions
Market based pricing strategies
Market skimming
In the case of books only one company own
the rights to publish. Wedgwood had created
an image/brand among the rich and famous
which others could not copy, especially if they
wished to undercut his prices. Consumer
durable products have high manufacturing
costs that deter too many companies entering
the industry.
Pricing Decisions
Market based pricing strategies
Penetration pricing
Penetration pricing occurs when a
company sets a very low price for the
new product initially.
The price will usually be below total
cost. The aim of the low price is to
establish a large market share quickly
by encouraging customers to try the
product and then to repeat buy.
Pricing Decisions
Market based pricing strategies
Penetration pricing
When this type of tactic is used,
therefore, where barriers to entry are
low. It is hoped to establish a dominant
market position, which will prevent new
entrants coming into the market
because they could not establish a
critical mass easily with prices are so
low.
Pricing Decisions
Market based pricing strategies
Penetration pricing
In the past, companies used penetration
pricing when they introduced a new
product, such as a new spray polish,
through supermarkets. The price would
be, say, between 60 per cent and 80
per cent of the ultimate price.
Pricing Decisions
Market based pricing strategies
Penetration pricing
Customers would buy the new product
largely because of its price and, it was
hoped, repeat buy either because they
did not notice the price increase or
because they did not mind paying for a
good product.
Pricing Decisions
Market based pricing strategies
Penetration pricing
If customers do notice the price
increase they are likely to be put off
further purchases if the increase is
too large. If a company succeeds with
this type of pricing it wins a large market
share very quickly which competitors
will find hard to break into.
Pricing Decisions
Market based pricing strategies
Price differentiation
If the market can be split into different
segments, each quite separate from the
others and with its own individual
demand function, it is possible to sell
the same product to different customers
at different prices.
Pricing Decisions
Market based pricing strategies
Price differentiation
Marketing techniques can be employed
to create market segmentation, if
natural demarcation lines are not
already in existence.
Pricing Decisions
Market based pricing strategies
Price differentiation
Segmentation will usually be on the
basis of one or more of the following:
 time (e.g. rail travel is cheaper off-peak,
hotel accommodation,
telecommunications);
 quantity (e.g. small orders at a
premium, bulk orders at a discount);
Pricing Decisions
Market based pricing strategies
Price differentiation
 type of customer (e.g. student and
Commercial);
 outlet/function (e.g. different prices for
wholesaler, retailer, end consumer);
 geographical location (e.g. stalls and
upper circle, urban and rural sites,
wealthy and poor districts, different
countries);
Pricing Decisions
Market based pricing strategies
Price differentiation
 product content (e.g. sporty versions of a
small car).
This type of pricing is of particular use where
a service provider (theatre, leisure centre,
train operator) has a high proportion of fixed
costs. By attracting those willing and able to
use the service at the less popular
time/location will help to improve profitability.
Pricing Decisions
Review MCQs
What is true related to the Penetration
pricing?
a. Focuses on certain customer segments
b. Always provides greater profitability.
c. Penetration pricing occurs when a
company sets a very low price for the
new product initially
d. Non of the above
Pricing Decisions
Review MCQs
What is true related to the Penetration
pricing?
a. Focuses on certain customer segments
b. Always provides greater profitability.
c. Penetration pricing occurs when a
company sets a very low price for the
new product initially
d. Non of the above
Pricing Decisions
Review MCQs
What is the true statement with regard to
Price differentiation?
a. Provides additional information related
to project costs.
b. Same product can be sold to different
customers at different prices
c. Changes in Project variables does not
affect the overall pricing strategy.
d. Non of the above.
Pricing Decisions
Review MCQs
What is the true statement with regard to
Price differentiation?
a. Provides additional information related
to project costs.
b. Same product can be sold to different
customers at different prices
c. Changes in Project variables does not
affect the overall pricing strategy.
d. Non of the above.
Pricing Decisions
Market based pricing strategies
Loss leader pricing
When a product range consists of one or
more main products and a series of related
optional ‘ extras ’, which the customer can ‘
add on ’ to the main product, the supplier can
set a relatively low price for the main product
and a high one for the ‘ extras ’ .
Obviously, the aim is to stimulate sufficient
demand for the former to ensure the target
return from sales of the latter.
Pricing Decisions
Market based pricing strategies
Loss leader pricing
The strategy has been used successfully by
aircraft engine manufacturers, who win an
order with a very competitively priced main
product that can only be serviced by their
own, highly priced spare parts.
Gillette did not invent the safety razor but the
market strategy Gillette adopted helped to
build market share.
Pricing Decisions
Market based pricing strategies
Loss leader pricing
Gillette razors were sold at 1/5 of the cost to
manufacture them but only Gillette blades
fitted and these were sold at a price of 5
cents. The blades cost only 1 cent to
manufacture and so Gillette made large
profits once it had captured the customer.
One of the best known uses of this technique
in recent years has been the sale of printer
ink for home printers.
Pricing Decisions
Market based pricing strategies
Loss leader pricing
Investigations by Computeractive magazine
showed that whilst the price of inkjet printers
can be as little as £34, the cost of running the
printer over an 18-month period could be up
to £1,700.
The top brand names for replacement ink
cartridges cost more per milliliter than vintage
champagne.
Pricing Decisions
Market based pricing strategies
Loss leader pricing
Even where the consumer only buys two
replacement cartridges a year, the cost of the
ink is likely to be significantly higher than the
cost of the initial printer.
Pricing Decisions
Market based pricing strategies
Product bundling
Bundling is putting a package of products
together to make, for example, a complete kit
for customers, which can then be sold at a
temptingly low price. It is a way of creating
value for customers and increasing company
profits.
Pricing Decisions
Market based pricing strategies
Product bundling
It is a strategy that is often adopted in times
of recession when organisations are
particularly keen to maintain sales volume.
One industry where this tactic started in the
recession of the early 1990s is the computer
industry.
A manufacturer might decide to substantially
reduce the profit margin on some hardware,
such as printers.
Pricing Decisions
Market based pricing strategies
Product bundling
It is a strategy that is often adopted in times
of recession when organisations are
particularly keen to maintain sales volume.
One industry where this tactic started in the
recession of the early 1990s is the computer
industry.
A manufacturer might decide to substantially
reduce the profit margin on some hardware,
such as printers.
Pricing Decisions
Market based pricing strategies
Product bundling
If, for example, only half its PC purchasers
would also buy the company’s model of
printer, a bundled package which includes the
PC and the printer for a lower combined price
may well prove very successful.
On the other hand, some customers will be
put off by product bundling as they do not
want the complete package; they will resent
the increased price, however small it is.
Pricing Decisions
Market based pricing strategies
Product bundling
Bundling can be extremely successful,
especially when tried on mature products for
the first time. For instance, Amstrad had
considerable success when it entered the hi-fi
market and demystified the technology by
being the first company to sell a complete
package of amplifier, deck and speakers.
Pricing Decisions
Market based pricing strategies
Product bundling
This was more than just a pricing strategy: it
was a complete marketing strategy. In recent
years the telecommunications industry has
successfully used this technique; first with TV
channel packages, and then more recently
extended to TV, broadband and phone
bundles.
Pricing Decisions
Market based pricing strategies
Product bundling
Whether a bundling strategy will succeed
depends on the predicted increase in sales
volume and the changes in margin. There are
likely to be other cost changes such as
savings in product handling, packaging and
invoicing costs.
Pricing Decisions
Market based pricing strategies
Using discounts in pricing
There are a number of reasons for using
discounts to adjust prices:
 To get cash in quickly. This is a not always a
financially sound strategy as the firm may
lose more in sales revenues from the
discount, than they would lose in interest from
a bank loan for the same amount.
Pricing Decisions
Market based pricing strategies
Using discounts in pricing
 To differentiate between different types of
customer, wholesale, retail, etc.
 To increase sales volume during a poor sales
period without dropping the price
permanently.
 Some industries give discounts as normal
practice, for example the antique trade, and
some retail shops seem to have semipermanent sales.
Pricing Decisions
Market based pricing strategies
Using discounts in pricing
 Perishable goods are often discounted
towards the end of their life or the end of the
day, or seconds are often sold off cheaply.
This may not be a good strategy as it does not
improve the company image, and some
customers may get wise and delay their
purchase until the end of the day when prices
are cheaper.
Pricing Decisions
Review MCQs
The purpose of providing discounts in
pricing are ?
a. Very difficult to implement
b. There is a lot of confusion with regard to
its application.
c. Able to get cash in quickly
d. Non of the above.
Pricing Decisions
Review MCQs
The purpose of providing discounts in
pricing are ?
a. Very difficult to implement
b. There is a lot of confusion with regard to
its application.
c. Able to get cash in quickly
d. Non of the above.
Pricing Decisions
Review MCQs
What is true related to the Product
Bundling ?
a. It is a way of creating value for
customers and increasing company
profits.
b. Very difficult to obtain customer
discounts
c. There is a lot of confusion with regard to
its application.
d. Non of the above.
Pricing Decisions
Review MCQs
What is true related to the Product
Bundling ?
a. It is a way of creating value for
customers and increasing company
profits.
b. Very difficult to obtain customer
discounts
c. There is a lot of confusion with regard to
its application.
d. Non of the above.
Pricing Decisions
Lecture Summary
We have discussed the
 Market based pricing strategies
Pricing Decisions
Management Level – Paper P2
Advanced Management Accounting
Lecture - 25
Vidya Rajawasam
ACMA CGMA MBA