Setting the right price

The real issue is value, not price ! Price is determined by what the consumer is willing to pay, not the cost to manufacture, distribute, and promote. promote

Setting the right price

The buying situation or context as well as the core dimension of the product determine what a consumer is willing to pay. For example: Consumers are willing to pay much more for a cup of coffee in Barista than in an Udipi restaurant They are willing to pay more for clothing they buy at Westside than for clothing they buy at Globus or Reliance Trends. They pay more for items like the latest cell phones than they should They want to purchase expensive perfume for gifts rather than cheap perfume even though the cost of manufacturing is not much different.

Setting the right price

Price is like a thermometer in that the higher we can push the price, the better job we have done with uncovering consumer needs and designing the marketing mix. It doesnt take any marketing skill to sell a product at a low price. Marketers earn their keep by getting a premium price for products and services. p yg g p p p Reference price is an important concept in pricing strategy. There is an external reference pricewhat everyone else is paying for the productand an internal reference pricewhat you think you should pay given your past experience and the buying situation. There are four basic pricing approachescost plus, value-in-use, penetration, and skimming, b t ultimately price d ki i but lti t l i depends on th core b fit of th product, th d the benefit f the d t the context, and how well youve done the rest of your marketing. Price is the most abstract of any of the four marketing mix elements. It is a signal of product quality and status. It is inherently subjective and tied to consumer perceptions rather than objective reality.

Price and Perceived Value

The Economic Perspective
Perceived Benefits Objective Price Perception of Price Perceived Costs Perceived Value Willingness to Buy

So, according to the economic perspective, consumers will purchase whenever

Perceived Value > 0

Price and Perceived Value

The Economic Perspective
Objective Value
Marketing Efforts

Perceived Value
Price of Substitutes

Consumers Incentive to Purchase = [Perceived Value Price] Product Price Firms Incentive to Sell = [Price COGS] Cost of Goods Sold Rs. 0

Price and Perceived Value

The Economic Perspective

Adding a Behavioral or Psychological Component

This perspective captures how fair a deal one is getting.

Behavioral Updates to Economic Perspective

Consumer Willingness to Buy

Economic Utility of the Transaction

Fairness of the Transaction

1. Relative Incentives
Perceived Value Actual Price Actual Price

2. Reference Prices
Actual Price Reference Price

Perceived V l A t l Price P i d Value Actual P i 3. Cost of Goods Sold

Actual Price COGS

4. Nature of the product

discretionary vs. necessary luxury vs. utilitarian

Setting the right price

Therefore to price correctly, you must understand the buying situation and the heart of the consumer.

Effect of Price on Profit

% Improvement in operating profits
Marketing Investments
12%

Fixed Costs

2%

Purchase Price

10%

Sales Price

14%

Sales Quantity

4%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Setting Pricing Policy

Consider the following six-step procedure for setting a price.
Stage 1: Selecting the Pricing Objective. Consider various types of pricing objectives. Stage 2: Determining Demand. Estimate demand curves and the magnitude of consumers sensitivities to demand. Stage 3: Estimating Costs. Estimate types of costs and identify experience curve. Stage 4: Analyzing Competitors Costs, Prices, and Offers. Consider competitors values. Stage 5: Selecting a Pricing Method. Consider various types of pricing methods . Stage 6: Selecting the Final Price. Consider the impacts of other marketing activities.

Setting Pricing Policy

1. Selecting the pricing objective 2. Determining demand 3. Estimating costs 4. Analyzing competitors competitors costs, prices, and offers 5. Selecting a pricing method 6. Selecting final price

Setting Pricing Policy

1. Selecting the pricing objective
Survival M i i sales revenue Maximize l Maximize profits Maximize growth (unit sales) market penetration experience curve Market skimming
Inelastic Demand Unique and patented product Uncertain production and marketing costs Capacity constraints in production High perceived value

Product Quality Leadership

Selecting the Pricing Objectives

Maximize Sales Revenue
Assume: P
250

Q = 1000 4P

Sales = P x Q Sales = P(1000-4P) Sales = 1000P 4P2 ds = 1000 8P dp 0 = 1000 8P 8P = 1000 P = 125

1000 Q
80000 60000 40000 20000 0 -20000 -40000 -60000 -80000 25 50 75 100 125 150 175 200 225 250 275 300

Selecting the Pricing Objectives

Maximize Profit
P
250

Q = 1000 4P

Profit = Sales - Cost Profit = (P x Q) [(VC x Q) + FC] Profit = P(1000 4P) [50 (1000-4P) + 6000] Profit = 1000P 4P2 50,000 + 200P - 6000 dprofit = 1200 8P dp 0 = 1200 8P

1000 Q

8P = 1200 P = 150
80000 60000 40000 20000 0 Revenue Cost 25 50 75 100 125 150 175 200 225 250 275 300 Profit

Cost

C = 6000 + 50Q

6000

-20000 -40000 -60000

-80000

Selecting the Pricing Objectives

Price Skimming and Penetration
Skimming Pricing
Price Sell at high price before reducing to next price level and repeat Price

Penetration Pricing

Initial Price Second Price Final Price

Whole market price

Quantity

Quantity

Selecting the Pricing Objectives

Experience Curve
Each time the cumulative production doubles, the cost in real amount will decline by a fixed percentage. This patte of cost decline is a result of: s pattern o dec e s esu t o : learning to perform tasks more efficiently technological improvements product redesigns economies of scale Example: 85% experience curve Each time total accumulated production doubles, cost will be reduced to 85% of its previous level. Implication: A firm can gain an advantage by accumulating experience faster than competitors.

Selecting the Pricing Objectives

Experience Curve
Formula Cn = Cs (Qn/Qs)b Where Cn = Cost now Cs = Cost starting Qn = Quantity now Qs = Quantity starting b = Experience coefficient
120 100

Assume: Cn = 85 Cs = 100 Qn = 4000 Qs = 2000

Solving for b: 85 = 100 (4000/2000)b 85 = 100 (2)b 85/100 = 2b ln 0.85 = b ln 2 -0.163 = b (0.693) -0.235 = b

Cost

80 60 40 20 0 0 2000 4000 6000 8000 10000 12000 14000

Cumulative Production

Selecting the Pricing Objectives

Price - Quality Strategies High Premium Value

Price
Medium High Value Low Super Value

Prod duct Quality

High

Med Overcharging

Medium Value

Good-Value

Low

Rip-Off

False Economy

Economy

Setting Pricing Policy

1. Selecting the pricing objective 2. Determining demand
Each price the company might charge will lead to a different demand and will therefore have a different impact on its marketing objectives. The relation between price and demand is captured in the familiar demand schedule. The demand curve shows the number of units the market will buy in a given time period at alternative prices. In the normal case, demand and price are inversely related, that is, the higher the price, the lower the demand.

Determining Demand
Pure Competition Many Buyers and Sellers Who Have Little Affect on the Price. Monopolistic Competition Many Buyers and Sellers Trading Over a Range of Prices. g

Different Types of Markets

Oligopolistic Competition Few Sellers Each Sensitive to Others Pricing/ Marketing Strategies

Pure Monopoly Single Seller

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Determining Demand
A. Inelastic Demand Demand hardly changes with a small change in Price. Pri ice

P2 P1

Quantity Demanded per Period

Q2

Q1

B. Elastic Demand Price

P2 P1

Demand changes greatly with a small change in Price. ll h i Pi

Q2

Q1

Quantity Demanded per Period

Determining Demand
Factors affecting price sensitivity unique value substitute awareness difficult comparison total expenditure end benefit shared cost sunk investment product quality inventory Methods of estimating demand lab test field test (in store) natural experiment

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Setting Pricing Policy

1. Selecting the pricing objective 2. Determining demand 2 D t i i d d 3. Estimating costs
Demand sets the ceiling for the price and Costs set the floor.

Low Price No possible profit at this price

Costs

Competitors prices and prices of substitutes

Customers assessment of unique product features

High Price No possible demand at this price

Setting Pricing Policy

1. Selecting the pricing objective 2. Determining demand g 3. Estimating costs 4. Analyzing competitors costs, prices, and offers Costs Competitors prices and prices of substitutes Customers assessment of unique product features

Low Price No possible profit at this price

High Price No possible demand at this price

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Analyzing Competitors Costs, Prices & Offers

Price-Reaction Program for Meeting a Competitors Price Cut
Has competitor cut his price? Yes Is the price likely to significantly hurt our sales? No No No Hold our price at present level; continue to watch competitors price

Yes

Is it likely to be a permanent price cut?

Yes

How much has his price been cut?

By less than 2% Include a cents-off coupon for the next purchase

By 2-4% Drop price by half of the competitors price cut

By more than 4% Drop price to competitors price

Setting Pricing Policy

1. Selecting the pricing objective 2. Determining demand 3. Estimating costs 4. Analyzing competitors competitors costs, prices, and offers 5. Selecting a pricing method

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Selecting a Pricing Method

What kinds of pricing methods can be considered? Cost-Based Pricing:
Markup pricing Break-even or target-return (target-profit) pricing.

Value-Based Pricing:
Perceived-value pricing. Value pricing

Competition-Based Pricing:
Going-rate pricing. pricing

Dynamic Pricing:
Bid-based or auction-type pricing.

Pricing Methods
Cost-Based Methods Price = Average Costs + Mark Up Market-Based Methods Price = Following Market Conditions Interaction Demand & Supply Competitor-Based Methods Price = Following Rival Prices Pricing Strategies

Mkt. Skimming Price

Mkt. Penetration Price

Discount Pricing and Segmented Pricing Strategies

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Mark-up or Cost-plus Pricing

To set price based on a desired mark-up (also called Cost-Plus . .Cost + some %) Mark-up = % profit based on cost Selling Price - Cost Cost Cost = Rs. 25; Desired mark-up = 20% i.e. Rs. 25 x 1.20 = Rs. 30

Cost-Plus Pricing delusion.. At Unit Variable Cost = Rs. 5 and Fixed Cost = Rs. 2,000 Demand =100 units ; Total Unit Cost = Rs. 25 ; Selling Price = Rs.30 Rs Rs 30 Demand =200 units ; Total Unit Cost = Rs. 15; Selling Price = Rs. 18 Demand =400 units ; Total Unit Cost = Rs. 10; Selling Price = Rs. 12

Mark-up or Cost-plus Pricing

Adding a Standard Markup to the Cost of the Product

Sellers Are More Certain About Costs Than Demand Perceived P i d Fairness to Both Buyers and Sellers

Minimizes Price Competition

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Target Return Pricing

A toy manufacturer invested Rs.10,00,000; wants 20% ROI; Fixed cost = Rs. 300,000; variable cost = Rs.10/unit Estimate = 50,000 unit sales (therefore, fixed cost/unit = Rs. 6). What is the price? Target-return price = unit cost + (invested capital x desired return) / unit sales

Target-return price = (10+6)+ (10,00,000 x 20% )/50,000 = Rs. 20

Target Return (Profit) Pricing

Tries to determine the Price at which a Firm will Break Even or make a Target Profit

C Cost in Rs. (thousands)

1,200 1,000 800 600 400 200

Target Profit (Rs. 200,000)

Total Revenue

Total Cost Fixed Cost

10

20

30

40

50

Sales Volume in Units (thousands)

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Value-Based Pricing
Cost-Based Pricing Value-Based Pricing

Product Cost Price Value Customers

Customer Value Price Cost Product

Perceived Value-Based Pricing

Perceived value the value of the benefits from the product/service in consumers mind. It include both product actual value and emotional value gain from using the product/service. The perceived value of a product/service differs from consumer to consumer.

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Perceived Value-Based Pricing

Perceived value A Price Amount Rs. Variable costs Fixed costs Profit

Perceived Value-based Pricing

Attributes Coffee Flavours Coffee Aroma Hygienic C diti H i i Conditions Quantity of Coffee Crockery & Cutlery Ambient Temperature Music Played Television/Video Seating Arrangement Time Restrictions? Attitude of Servers Average Score Sai Sagar 1 1 3 3 2 2 1 1 2 2 3 1.91 Barista 7 7 7 6 7 7 7 7 7 7 6 6.82

If Sai Sagar Coffee is Rs. 12.00 then Perceived Value of Barista Coffee will be Rs.12 x (6.82/1.91) = Rs. 43

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Competition-Based Pricing
Setting Prices

Going-Rate
Company sets Prices based on what Competitors are charging.

Sealed-Bid
Company sets Prices based on what they think Competitors will charge.

Selecting the Final Price

Types of pricing strategies that are popular
Fi d P i i Strategies: Fixed Pricing St t i
Setting one price for all buyers. Examples: Price leadership strategy and promotional strategy, etc.

Segmented Pricing Strategies:

Charging different prices for different customers. Examples: Segmented pricing such as geographic and value pricing, etc.

Dynamic or Negotiated Pricing Strategies:

Charging different prices for individual customers. Examples: online auctions, name your own price, etc.

Pricing Strategies for Information Goods:

Considering the cost structure of information goods.

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Pricing Strategies for Information Goods

First-Degree Price Discrimination
The firm sells different units of the product for different prices and these prices may differ from consumer to consumer. It is known as perfect price discrimination.

Second-Degree Price Discrimination

The firm sells different units of a product for different prices, but every individual who buys the same amount of the product pays the same price. One example is quantity discount.

Third-Degree Price Discrimination

The firm sells the product to different p p for different p p people prices, but , every unit of product sold to a given individual sells for the same price. Examples are senior citizens discount, student discount.

Examples of Pricing Strategies

Product Line Pricing
Setting price steps between product line items i.e. Rs. 299, Rs. 399

OptionalOptional-Product Pricing
Pricing ti P i i optional or accessory products l d t sold with the main product i.e. Car Options

Traditional Pricing Strategies

CaptiveCaptive-Product Pricing
Pricing products that must be used with the main product i.e. Razor Blades, Film, Software, Printer Cartridges

ByBy-Product Pricing
Pricing low-value by-products to get rid of them i.e. Cut-pieces from a fabric length

ProductProduct-Bundle Pricing
Pricing bundles of products sold together i.e. Soaps, Shirts, Dresses

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Examples of Pricing Strategies

Psychological Pricing Promotional Pricing
Adjusting prices for psychological effect. Price used as a Quality indicator. i.e. Sony Bravia LCD TV vs Samsung or LG Temporarily reducing prices to increase short-run sales. i.e. Loss Leaders, Special-Events Adjusting Prices to account for the geographic location of customers. i.e. FOB-Origin, Uniform-Delivered, Zone Pricing & Freight-Absorption. Adjusting prices for International markets. i.e. Price depends on Costs, Consumers, Economic Conditions & Other Factors.

Geographical Pricing

International Pricing

Examples of Pricing Strategies

Traditional Pricing Strategies Discount & Allowance
Reducing Prices to Reward Customer Responses such as Paying Early or Promoting the Product. Cash Discount Quantity Discount Functional Discount Seasonal Discount Trade-In Allowance

Segmented g
Adjusting Prices to Allow for Differences in Customers, Products, or Locations.

Customer Product Form Location Time

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Versioning
A form of second-degree price discrimination i.e. Premium and Economy Pricing

Bundling

Pricing Strategies for Information Goods

Many information goods are sold in large bundles i.e. Music files in an album, MS Office

FixedFixed-Fee Pricing
Giving customers unlimited usage for a flat fee i.e. Unlimited Internet usage By MTNL

Other Pricing Strategies

Using first-degree price discrimination i.e. Online auctions at eBay

Other Pricing Strategies

Using third-degree price discrimination i.e. Group pricing for software

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