Download pricing strategies

MBA
Marketing Management
MKT 600
Price in Mktg Mngnt & pricing strategy
Pricing Decisions
Lecture Overview
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Introduction
Theory of Pricing
Pricing Objectives
Strategic Determinants of Price
Costs
Demand
Competition
 Positioning of Life Cycles
 Pricing Strategies
Market skimming
Market penetration
Destroyer pricing
Promotional pricing
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INTRODUCTION
All products and services have a price just as they have value. Many non-profit and all
profit-making organisations must also set prices, be they; the price to see a consultant
doctor or to buy a pair of trainers or a price to visit the island where Princess Diana lies.
Pricing is a measure of what a product is worth in that it sets a value for a product and
service – but it also goes under many names. For example,
 Rent for your flat
 Tuition for your education
 Fee to see your dentist
 Airline, bus and taxi firms charge a fare
 A guest lecturer charges an honorarium
 Clubs and societies charge subscriptions
 Lawyers may ask for a retainer
Definition -
‘Price is the sum of all the values that consumers exchange for the
benefits of having or using the product and service.’
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Probably the single most important decision in marketing is price, in that economists
will agree that price directly affects sales volumes. If a price is too high and the market
competitive, sales will fall.
On the other hand, many marketers have found ways to reduce the impact of price. In the
case of non-profit organisations there simply is no price (eg seeing a doctor) and as such
may not be applicable.
On the other hand, some principles can still be applied if ‘price’ is replaced by the
‘perceived value’ to the customer. In this way the customers put a value (often a high
value) on the service, and this can be dealt with much as price is itself.
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THEORY OF PRICING
Much of the theory of pricing is derived from that of economics. The basic idea is that,
‘Demand will be different at each price level chosen’
As can be seen from the diagram, demand normally (but not always) falls as price increases.
Price
Demand curve
Quantity demanded
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Alternatively, supply normally increases as prices rise (the reverse of demand), gaining
the supply curve (see below).
Price
Supply curve
Quantity supplied
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In theory, prices changed will be set such that demand and supply are equally balanced,
such that demand = supply. This point is called the equilibrium price, as shown below.
Price
Supply
£
Equilibrium
Price
Demand
Quantity
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The problem with economic theory is it discounts to a great extent. The fact that buyers
today are no longer restricted to buying essentials but can indulge in choice products,
including luxuries. The suppliers of these products differentiate them (via the marketing
mix) such that they can be more flexible with their pricing.
Price Elasticity of Demand – Different markets for products ad services have different
levels of sensitivity towards the prices changed. The degree to which demand is sensitive
to price is called ‘price elasticity of demand’.
Definition -
Price elasticity of demand is the percentage change in the quantity of
a good demanded, divided by the corresponding percentage change
in its price,
or
price elasticity of demand
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=
change of demand (%)
change of price (%)
In the commodities market, for example, where products such as; salt, cement, oil etc
are often undifferentiated, the demand for your product will be very dependent on the
price you seek.
Where a company sets it commodity prices above the market price it is unlikely to sell its
product. Here the products price is said to be elastic.
At the other end of the spectrum there are products that are very insensitive in terms of
price. These products or services are often highly differentiated such that the market is
willing to pay a higher price.
Products and services are often branded to reflect this differentiation and so claim a
premium price. Demand for such products/brands are often called ’price inelastic’.
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PRICING OBJECTIVES
 Survival – Under service competitive pressure, in order to survive companies will cut prices
to the extent they do not cover all their costs – so long as it generates cash to keep the
company going.
 Profit Maximisation – In the long-term all companies must make profits otherwise their
future will be uncertain.
 Sales Maximisation – Generating lots of sales can lead to reduced unit costs and so make
the company more profitable as well as dominant in its market sector.
 Price competition – A competitive price is not necessarily the lowest price, but it is one that
gives the company a competitive advantage in the marketplace. For example, Gillette razor
blades are often priced higher than their competitors because they are perceived to provide
a much higher quality than their competitors. This quality leadership means they can change
and are expected to change to a higher price. Rolls Royce cars are expensive products that
maintain their competitive edge in international markets because of the combination of
benefits offered through the marketing mix, including a high price.
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Variable Costs
Fixed Costs
Margin
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STRATEGIC DTERMINANTS OF PRICE
There are 3 major influences on pricing decisions. These are Cost
Demand
Competition
Costs
The quantity of products sold ( ie sales volume) is a critical factor in the success of any
business. The reason is that every business has to pay 2 different kinds of costs
associated with sales, fixed costs and variable costs.
Types of Costs
Fixed Costs – Are so called because they remain the same mo matter how many units
of product are sold. (Such costs include; rent, rates, heating, lighting, wages,
depreciation, insurance etc.)
Variable Costs – Are those that vary directly according to the number of units
produced/sold. (Such costs include; materials and components, machine running time
etc)
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The difference between the variable cost per unit of product and the price paid by the
customer is called the margin. While the rates of variable costs to the margin remains
constant no matter how many units are sold, the rates of fixed costs to margin changes
with the number of units sold. For example;
If your fixed costs are £1000 a year and you sell 100 units, then each unit will gave to
carry £10 of fixed costs. If on the other hand you sell 500 units then each unit only has to
carry £2 of fixed costs which makes a big difference when you come to price the product.
Cost Plus Pricing – The vast majority of firms price their products based on mark up on
the cost providing the product or service concerned. The reason it is simple to calculate is
information on costs are often well defined by accountants so firms simply add a margin
to the unit cost.
The unit cost is the average cost of each item produced. If a firm produces 800 units a
total cot of £24,000 the unit cost will be £30. many small businesses will tell you they
‘cost out’ each hour worked and then add a margin for profits. For example, fashion
clothes sold by retailers are marked up between 75-150%.
The process if cost plus pricing can best be illustrated in relation to large firms where
economies of scale can be spread over a considerable range of output. Whilst very
popular, there are dangers attached. If the price is set too high, a sale will be lost; if set
too low, profit will be lost.
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Firms that operate in international markets tend to favour cost-plus pricing because it
involves using a simple formula rather than having to calculate the relative strength of
demand in lots of quite different markets. However, if this method is applied too rigidly, it
can cause problems in the marketplace.
For example, if demand is lower than expected, unit costs may be slightly higher. In this
case the accountants may well seek to raise prices. This will in turn make sales even
harder to achieve. If on the other hand, demand is higher than expected, unit costs may
fall and a price reduction may be sought which could lead to loss of revenue and profit.
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Contribution Pricing – This involves separating out the different product that make up a
company’s portfolio in order to change individual prices appropriate to a product’s share in
total costs. We have already identified the 2 broad categories of costs: variable (direct)
costs vary with the quantity of output produced or sold; fixed (indirect) costs have to be
paid irrespective of the level of output or sales.
While it is easy to attribute direct costs to products it is not always that simple to
indirect
costs, such as,
wages, business, rent and rates etc. however, if we can identify the
variable costs we can at least identify each products ability to cover its direct cost and
assess how much is left over to contribute to fixed costs.
Revenue from Product X
–
Direct variable costs
= Contribution of X
Revenue of Product Y
–
Direct variable costs
= Contribution of Y
The total of all the contribution should cover all the fixed costs. Any balance is called the
profit.
Contribution is an excellent way of pricing for firms selling to a range of international
markets which share a common fixed cost base.
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Demand
Demand orientated pricing involve reacting to the intensity of demand for a product, so that
high demand leads to high prices and work demand ti low prices, even though unit costs are
similar.
When a firm can segment its market into different groups, it can carry out a policy of price
discrimination. This involves selling at high prices in segments of the market where demand
is intense (ie where demand is inelastic and at relatively low prices where demand is elastic.
Customer Orientated Discrimination – Customers are often willing to pay a high price
when something is new. They also have an expectation of what price to pay. Therefore, firms
can, and often do, charge different prices for the same product at different times and in
different locations. For example, many boos are initially sold in hardbook at a high price, but
when the innovator section of the market is satisfied, a cheaper paperback version is
released at a lower price to attract other market sectors.
Time Orientated Discrimination – Demand for a service or product can vary by season or
even the time of day. At these peak demand time, products/service are often charged at a
high price and at off peak time at a lower price. This applies to a wide variety of items from
fashion clothes to train and air services.
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Product Orientated Discrimination – Slight modification to products can allow for high
and low price strategies. For example, many car models have additional extras (eg 2 or
4 door version, with or without sunroof etc). Customers have a choice of the cheaper
basic model or a more expensive version.
Situation Orientated Discrimination – Products or services can change more or less
based on their situation or location. For example, demand for houses can very dependant
on the location of the house, cinema and theatre seats may be priced according to their
proximity to the screen or stage.
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Competition
The nature and extent of competition is frequently an important influence on price. If
forced by direct competition, then the product will compete against very similar products
in the marketplace and as such with little differentiation prices will need to be I line with
rival prices.
In contrast, when a product is faced with indirect competition (ie competition with
products in different sectors of the market) then there will be more scope to vary price.
For example, a firm may choose a high price strategy to give a product or brand a
‘quality’ feel. In contrast, it might change a low price so that consumers view the product
as a bargain.
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However, Hatton and Oldroyd have shown there is a price floor and a price ceiling in
which marketers can set prices, as shown below -
Price Ceiling
Demand
What the market will
Competitors
Price
Range
Costs
Price Floor
Within this band, there may be
avoid retaliatory responses.
agreement between competitors (eg petrol/cigarettes) to
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POSITIONING AND LIFE CYCLES
The price a company sets impacts on the position of its products the competition in
terms of quality.
It may be necessary to change the price of a product as it moves through its life cycle
and hence needs to be repositioned.
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Introduction - High performance costs – high prices
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Growth -
High performance costs but also sales growth – prices become more
competitive.
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Maturity -
Lower promotional costs – Sales growth slow, profit taken, prices
stabilise at level determined by market share/volume/demand
relationships.
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Decline -
Minimal promotional costs
Sales decline
Prices reduced
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PRICING STRATEGIES
Pricing can be used as an in tool to pursue short term marketing and selling targets for a
company. Typical attack based policies/strategies include –
Skimming pricing
Destroy pricing
Penetration pricing
Promotional pricing
Market Skimming – Often used when launching anew product into a market where there is
little direct competitions in the market so demand for the product may be somewhat inelastic.
Skimming involves setting a relatively high (or very high) initial price in order to yield high
returns from the consumers willing to buy the product as shown below -
First layer of customers
Second layer
Third layer
etc
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Market Penetration – This method offers low prices to attract large numbers of
customers and so gain market share by penetrating the existing market. The method
works best where demand is relatively elastic and increased sales can have a great
effect on reducing the unit cost per sale.
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High fixed costs
Demand elastic
Economies of scale
Lots of customers
Penetration pricing
A typical example would be a new breakfast cereal or a product
overseas market.
Leads to
increased
sales and
market
share
launched in a new
Initially it would be launched with a relatively low price, coupled to discounts and special
offers. As the product penetrates the market, sales and profitability increase. Prices can
then creep upwards.
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Destroyer Pricing – This policy can be used to undermine the sales of rivals or to warn
potential new rivals not to enter the market. Destroyer pricing involves reducing the price
of an existing product at an artificial low price in order to destroy competitor sales as
shown below –
Price
Natural Market Price
Price which yields lowest acceptable
long-term return on capital invested
Destroyer
price range
When entered the UK market in the mid 90s, British supermarkets slashed their prices
in the localities close to the new stores in an attempt to kill off the American rival.
Supermarkets continue to practice similar tactics in their local business environments in
order to close down the number of local independent traders around them.
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Promotional Pricing – This policy is used to inject fresh life into an existing product or to
create new interest in a new product. It can help to increase the rate at which the product
is turned over, which can reduce stock levels. Loss leaders are products whose price has
been reduced in order to boast its sales, but also the sales of products closely associated
to it.
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