Pricing strategies

From Wikipedia, the free encyclopedia

Pricing strategies for products or services encompass three main ways to improve profits. These are that the
business owner can cut costs or sell more, or find more profit with a better pricing strategy. When costs are
already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay
viable.
Merely raising prices is not always the answer, especially in a poor economy. Too many businesses have been
lost because they priced themselves out of the marketplace. On the other hand, too many business and sales
staff leave "money on the table". One strategy does not fit all, so adopting a pricing strategy is a learning curve
when studying the needs and behaviors of customers and clients.
[1]

Models of pricing
Cost-plus pricing
Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds
on a percentage (profit) to that price to give the selling price. This method although simple has two flaws; it
takes no account of demand and there is no way of determining if potential customers will purchase the product
at the calculated price.
This appears in two forms, Full cost pricing which takes into consideration both variable and fixed costs and
adds a % markup. The other is Direct cost pricing which is variable costs plus a % markup, the latter is only
used in periods of high competition as this method usually leads to a loss in the long run.
Creaming or skimming
In most skimming, goods are sold at higher prices so that fewer sales are needed to break even. Selling a
product at a high price, sacrificing high sales to gain a high profit is therefore "skimming" the market. Skimming
is usually employed to reimburse the cost of investment of the original research into the product: commonly
used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a
high price. This strategy is often used to target "early adopters" of a product or service. Early adopters
generally have a relatively lower price-sensitivity - this can be attributed to: their need for the product
outweighing their need to economise; a greater understanding of the product's value; or simply having a higher
disposable income.
This strategy is employed only for a limited duration to recover most of the investment made to build the
product. To gain further market share, a seller must use other pricing tactics such as economy or penetration.
This method can have some setbacks as it could leave the product at a high price against the competition.
[2]


Limit pricing
A limit price is the price set by a monopolist to discourage economic entry into a market, and is illegal in many
countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm
did not decrease output. The limit price is often lower than the average cost of production or just low enough to
make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is
usually larger than would be optimal for a monopolist, but might still produce higher economic profits than
would be earned under perfect competition.
The problem with limit pricing as a strategy is that once the entrant has entered the market, the quantity used
as a threat to deter entry is no longer the incumbent firm's best response. This means that for limit pricing to be
an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the
incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this
would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. In
this strategy price of the product become limit according to budget.
Loss leader

A loss leader or leader is a product sold at a low price (i.e. at cost or below cost) to stimulate other profitable
sales. This would help the companies to expand its market share as a whole.
Market-oriented pricing
Setting a price based upon analysis and research compiled from the target market. This means that marketers
will set prices depending on the results from the research. For instance if the competitors are pricing their
products at a lower price, then it's up to them to either price their goods at an above price or below, depending
on what the company wants to achieve .
Penetration pricing
Setting the price low in order to attract customers and gain market share. The price will be raised later once this
market share is gained.
[3]

Price discrimination
Setting a different price for the same product in different segments to the market. For example, this can be for
different ages, such as classes, or for different opening times, .
Premium pricing
Premium pricing is the practice of keeping the price of a product or service artificially high in order to encourage
favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not
necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation, are
more reliable or desirable, or represent exceptional quality and distinction.
Predatory pricing
Aggressive pricing (also known as "undercutting") intended to drive out competitors from a market. It is illegal in
some countries.
Contribution margin-based pricing
Contribution margin-based pricing maximizes the profit derived from an individual product, based on the
difference between the product's price and variable costs (the product's contribution margin per unit), and on
ones assumptions regarding the relationship between the products price and the number of units that can be
sold at that price. The product's contribution to total firm profit (i.e. to operating income) is maximized when a
price is chosen that maximizes the following: (contribution margin per unit) X (number of units sold)..
Psychological pricing
Pricing designed to have a positive psychological impact. For example, selling a product at $3.95 or $3.99,
rather than $4.00.
Dynamic pricing
A flexible pricing mechanism made possible by advances in information technology, and employed mostly by
Internet based companies. By responding to market fluctuations or large amounts of data gathered from
customers - ranging from where they live to what they buy to how much they have spent on past purchases -
dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customers
willingness to pay. The airline industry is often cited as a dynamic pricing success story. In fact, it employs the
technique so artfully that most of the passengers on any given airplane have paid different ticket prices for the
same flight.
[4]

Price leadership
An observation made of oligopolistic business behavior in which one company, usually the dominant competitor
among several, leads the way in determining prices, the others soon following. The context is a state of limited
competition, in which a market is shared by a small number of producers or sellers.
Target pricing
Pricing method whereby the selling price of a product is calculated to produce a particular rate of return on
investment for a specific volume of production. The target pricing method is used most often by public utilities,
like electric and gas companies, and companies whose capital investment is high, like automobile
manufacturers.
Target pricing is not useful for companies whose capital investment is low because, according to this formula,
the selling price will be understated. Also the target pricing method is not keyed to the demand for the product,
and if the entire volume is not sold, a company might sustain an overall budgetary loss on the product.
Absorption pricing
Method of pricing in which all costs are recovered. The price of the product includes the variable cost of each
item plus a proportionate amount of the fixed costs and is a form of cost-plus pricing
High-low pricing
Method of pricing for an organization where the goods or services offered by the organization are regularly
priced higher than competitors, but through promotions, advertisements, and or coupons, lower prices are
offered on key items. The lower promotional prices are designed to bring customers to the organization where
the customer is offered the promotional product as well as the regular higher priced products.
[5]

Premium decoy pricing
Method of pricing where an organization artificially sets one product price high, in order to boost sales of a
lower priced product.
Marginal-cost pricing
In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of
output. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting
from materials and direct labor. Businesses often set prices close to marginal cost during periods of poor sales.
If, for example, an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the
item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach
because the incremental profit of 10 cents from the transaction is better than no sale at all.
Value-based pricing
Pricing a product based on the perceived value and not on any other factor. Pricing based on the demand for a
specific product would have a likely change in the market place.
Pay what you want
Pay what you want is a pricing system where buyers pay any desired amount for a given commodity,
sometimes including zero. In some cases, a minimum (floor) price may be set, and/or a suggested price may
be indicated as guidance for the buyer. The buyer can also select an amount higher than the standard price for
the commodity.
Giving buyers the freedom to pay what they want may seem to not make much sense for a seller, but in some
situations it can be very successful. While most uses of pay what you want have been at the margins of the
economy, or for special promotions, there are emerging efforts to expand its utility to broader and more regular
use.
Freemium
Freemium is a business model that works by offering a product or service free of charge (typically digital
offerings such as software, content, games, web services or other) while charging a premium for advanced
features, functionality, or related products and services. The word "freemium" is a portmanteau combining the
two aspects of the business model: "free" and "premium". It has become a highly popular model, with notable
success.
Odd pricing
In this type of pricing, the seller tends to fix a price whose last digits are odd numbers. This is done so as to
give the buyers/consumers no gap for bargaining as the prices seem to be less and yet in an actual sense are
too high. A good example of this can be noticed in telephone promotions of some countries like Uganda where
instead of writing the price as sh. 40000, they write it as sh. 39999. This pricing policy is common in economies
using the free market policy.
Nine Laws of Price Sensitivity and Consumer Psychology
In their book, The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline nine "laws" or
factors that influence how a consumer perceives a given price and how price-sensitive they are likely to be with
respect to different purchase decisions.
[6][7]

They are:
1. Reference Price Effect buyers price sensitivity for a given product increases the higher the
products price relative to perceived alternatives. Perceived alternatives can vary by buyer segment,
by occasion, and other factors.
2. Difficult Comparison Effect buyers are less sensitive to the price of a known or more reputable
product when they have difficulty comparing it to potential alternatives.
3. Switching Costs Effect the higher the product-specific investment a buyer must make to switch
suppliers, the less price sensitive that buyer is when choosing between alternatives.
4. Price-Quality Effect buyers are less sensitive to price the more that higher prices signal higher
quality. Products for which this effect is particularly relevant include: image products, exclusive
products, and products with minimal cues for quality.
5. Expenditure Effect buyers are more price sensitive when the expense accounts for a large
percentage of buyers available income or budget.
6. End-Benefit Effect the effect refers to the relationship a given purchase has to a larger overall
benefit, and is divided into two parts: Derived demand: The more sensitive buyers are to the price of
the end benefit, the more sensitive they will be to the prices of those products that contribute to that
benefit. Price proportion cost: The price proportion cost refers to the percent of the total cost of the
end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU
and PCs). The smaller the given components share of the total cost of the end benefit, the less
sensitive buyers will be to the component's price.
7. Shared-cost Effect the smaller the portion of the purchase price buyers must pay for themselves,
the less price sensitive they will be.
8. Fairness Effect buyers are more sensitive to the price of a product when the price is outside the
range they perceive as fair or reasonable given the purchase context.
9. The Framing Effect buyers are more price sensitive when they perceive the price as a loss rather
than a forgone gain, and they have greater price sensitivity when the price is paid separately rather
than as part of a bundle.


Individual pricing Strategies In Detail

Limit pricing
A limit price is the price set by a monopolist to discourage entry into a market, and is illegal in many
countries. The limit price is the price that a potential entrant would face upon entering as long as the
incumbent firm did not decrease output. The limit price is often lower than the average cost of production
or just low enough to make entering not profitable. Such a pricing strategy is called limit pricing.
[1]

The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be
optimal for a monopolist, but might still produce higher economic profits than would be earned
under perfect competition.
The problem with limit pricing as strategic behavior is that once the entrant has entered the market, the
quantity used as a threat to deter entry is no longer the incumbent firm's best response. This means that
for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way
to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry
occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high)
level of labor for a long period of time.
[2]
Another example is to build excess production capacity as a
commitment device.
Simple Example
In a simple case, suppose industry demand for good X at market price P is given by:

Suppose there are two potential producers of good X, Firm A, and Firm B. Firm A has no fixed costs and
constant marginal cost equal to . Firm B also has no fixed costs, and has constant marginal cost
equal to , where (so that Firm B's marginal cost is greater than Firm A's).
Suppose Firm A acts as a monopolist. The profit-maximizing monopoly price charged by Firm A is then:

Since Firm B will never sell below its marginal cost, as long as , Firm B will not enter the
market when Firm A charges . That is, the market for good X is an effective monopoly if:

Suppose, on the contrary, that:

In this case, if Firm A charges , Firm B has an incentive to enter the market, since it can sell a
positive quantity of good X at a price above its marginal cost, and therefore make positive profits. In order
to prevent Firm B from having an incentive to enter the market, Firm A must set its price no greater
than . To maximize its profits subject to this constraint, Firm A sets price (the limit price).








Cost-plus pricing
Cost-plus pricing is a pricing method used by companies to maximize their profits.
The firms accomplish their objective of profit maximization by increasing their production until marginal
revenue equals marginal cost, and then charging a price which is determined by the demand curve. However,
in practice, most firms use cost-plus pricing, also known as markup pricing. There are several varieties, but
the common thread is that one first calculates the cost of the product, then adds a proportion of it as markup.
Basically, this approach sets prices that cover the cost of production and provide enough profit margin to the
firm to earn its target rate of return.
[1]
It is a way for companies to calculate how much profit they will make.
Cost-plus pricing is often used on government contracts (cost-plus contracts), and has been criticized as
promoting wasteful expendises direct costs, indirect costs, and fixed costs whether related to the production
and sale of the product or service or not. These costs are converted to per unit costs for the product and then a
predetermined percentage of these costs is added to provide a profit margin.
Cost-plus pricing is used primarily because it is easy to calculate and requires little information. Information on
demand and costs is not easily available, managers have limited knowledge as far as demand and costs are
concerned. This additional information is necessary to generate accurate estimates of marginal costs and
revenues. However, the process of obtaining this additional information is expensive. Therefore, cost-plus
pricing is often considered the most rational approach in maximizing profits. This approach relies on arbitrary
costs and arbitrary markups.
Mechanics of cost-plus pricing
There are two steps which form this approach. The first step involves calculation of the cost of production, and
the second step is to determine the markup over costs.
1. Calculation of cost of production
The total cost has two components: Total Variable cost and Total fixed Cost.In either case,costs are computed
on an average basis. That is
AC =AVC +AFC
Where
AVC =TVC /Q
AFC = TFC /Q
AC= average cost
AVC= Average variable cost
AFC=Average fixed cost
TVC=Total variable cost
TFC=Total fixed cost
Q=Quantity (the number of units produced)
In this approach, the quantity is assumed.In cost-plus pricing we use quantity to calculate price but price is the
determinant of quantity.To avoid this problem, the quantity is assumed.This rate of output is based on some
percentage of the firm's capacity.
[1]

2. Determining the markup over costs
The objective of this approach is to set prices in a manner that a firm earns its targeted rate of return. Now, if
that return is Rs.X (Rs.= Ratio of the respective share) of total profit then the markup over costs on each unit of
output will be X/Q and then the price will be: P =AVC +AFC +X /Q
[1]

Reasons for wide use
Firms vary greatly in size, product range, product characteristics etc. Firms also face different degrees of
competition in markets for their products. So, a clear explanation cannot be given for the widespread use of
cost-plus pricing. However the following points explain as to why this approach is widely used:
[2]

Even if a firm handles many products, this approach provides the means by which fair prices can be found
easily
This approach involves calculation of full cost. Prices based on full cost look factual and precise and may
be more defensible on moral grounds than prices established by other means
This approach reduces the cost of decision-making. Firms which prefer stability use cost-plus pricing as a
guide to price products in an uncertain market where knowledge is incomplete
Firms are never too sure about the shape of their demand curve neither are they very sure about the
probable response to any price change.So, it becomes risky for a firm to move away from cost-plus pricing
Unknown reaction of rivals to the set price is a major uncertainty.When products and production processes
are similar competitive stability is achieved by usage of cost-plus pricing. This competitive stability is
achieved by setting a price that is likely to yield acceptable returns to other members of the industry
Management tends to know more about product costs than any other factors which can be used to price a
product
Insures seller against unpredictable, or unexpected later costs
Ethical advantages (see just price)
Simplicity
Ready availability
Price increases can be justified in terms of cost increases
[edit]Usefulness
Cost-plus pricing is specially useful in the following cases:
Public-utility Pricing
Finding out the design of the product when the selling price is predetermined i.e. product tailoring.By
working back from this price,the product and the permissible cost is decided upon.This means that market
realities are taken into account as this approach considers the viewpoint of the buyer in terms of what he
wants and what he will pay
Pricing products that are designed to the specification of a single buyer-the basis of pricing is the
estimated cost plus gross margin that the firm could have got by using facilities otherwise
Cost-plus pricing is useful in cases like 'Monopsony Buying' - here, the buyers have enough knowledge
about suppliers' costs.Thus, they may make the product themselves if they do not comply with the offered
prices. So, relevant cost would be the cost which a buying company would incur if it made the product
itself
[edit]Disadvantages
Provides incentive for inefficiency
Tends to ignore the role of consumers
Tends to ignore the role of competitors
Uses historical rather than replacement value
Uses normal or standard output level to allocate fixed costs
Includes sunk costs rather than just using incremental costs
Ignores opportunity cost
Cost-plus pricing and economic theory
Cost-plus pricing might appear to be inconsistent with the economic theory of profit maximization. Analysis
based on marginal cost equals marginal revenue decision rule may appear to have become irrelevant due to
the wide use of cost-plus pricing.However, this conflict is more apparent than real. A comparison of the two
approaches to pricing starts with a consideration of costs. Cost-plus pricing is based on average costs and not
marginal costs.However, in economic theory long-run marginal and average costs are not very different. Thus,
it can be said safely that usage of average costs for pricing may be considered a reasonable approximation of
marginal cost decision making.
[3]

Second step in comparison involves the target rate of return and the resulting markup. Determination of the
target rate of return depends on certain factors. Basically, the decision involves management's perception of
demand elasticity and competitive conditions. This can be explained with an example,consider grocery
stores.Profits are held down to the intense competition that exists among these firms. Due to this intense
competition the markup for most food items is only about 12 percent over cost. If the markup over cost is based
on demand conditions,cost-plus pricing may not be inconsistent with profit maximization. This can be shown
mathematically.
[1]

Marginal revenue is the derivative of total revenue with respect to quantity. Thus
MR =d (TR)/ dQ =d (PQ)/ dQ =P +dP*Q /dQ
(P + dP *Q /dQ) can also be written as P (1 + dPQ /dQP) .Here, (dP /dQ) (Q /P) is 1/E
P
, where E
P
is price
elasticity of demand. Thus
MR =P (1 +1/E
P
) (equation 1)
In order to maximize profit MR should be equal to MC.To simplify the assumption let MC=AC. Thus the profit
maximizing price is the solution to
P (1 +1/E
P
) =AC
which can be written as
P (E
P
+1 /E
P
) =AC
Solving for P yields
P =AC (E
P
/E
P
+1) (equation 2)
Equation 2 can be interpreted as a cost-plus pricing or markup pricing scheme.That is the price of the product
is based on markup over average costs. (E
P
+ 1 /E
P
) which is the markup is a function of the price elasticity of
demand. From the equation we can see that the markup and the price elasticity of demand are inversely
related, as the demand becomes more elastic the markup becomes smaller.
[









Loss leader Pricing
From Wikipedia, the free encyclopedia
A loss leader, or simply a leader,
[1]
is a product sold at a low price (at cost or below cost)
[2]
to stimulate other
profitable sales. It is a kind of sales promotion, in other words marketing concentrating on a pricing strategy. A
loss leader is often a popular article. Sometimes leader is now used as a related term and means any popular
article, in other words one sold at a normal price.
[3]

Sales of other items in the same visit
One use of a loss leader is to draw customers into a store where they are likely to buy other goods. The vendor
expects that the typical customer will purchase other items at the same time as the loss leader and that the
profit made on these items will be such that an overall profit is generated for the vendor.
Loss Lead describes the concept that an item is offered for sale at a reduced price and is intended to lead to
the subsequent sale of other items, the sales of which will be made in greater numbers, or greater profits, or
both. It is offered at a price below its minimum profit marginnot necessarily below cost. The firm tries to
maintain a current analysis of its accounts for both the loss lead and the associated items, so it can monitor
how well the scheme is doing, as quickly as possible, thereby never suffering an overall net loss.
An example is a supermarket selling sugar or milk at less than cost to draw customers to that particular
supermarket.
Marketing academics have shown that retailers should think of both the direct and indirect effect of substantial
price promotions when evaluating their impact on profit.
[4]
To make a very precise analysis one should also
include effects over time. Deep price promotions may cause people to bulk-buy (stockpile), which may
invalidate the long-term effect of the strategy. This is the association rule analysis.
[5]

When automobile dealerships use this practice, they offer at least one vehicle below cost and must disclose all
of the features of the vehicle (including the VIN). If the loss leader vehicle has been sold, the salesperson tries
to sell a more upscale trim of that vehicle at a slightly discounted price, as a customer who has missed the loss
leading vehicle is unlikely to find a better deal elsewhere.
Characteristics of loss leaders
A loss leader may be placed in an inconvenient part of the store, so that purchasers must walk past other
goods which have higher profit margins.
A loss leader is usually a product that customers purchase frequentlythus they are aware that its
unusually low price is a bargain.
Loss leaders are often scarce, to discourage stockpiling. The seller must use this technique regularly if he
expects his customers to come back.
The retailer will often limit how much a customer can buy.
Some loss leader items are perishable, and thus can't be stockpiled
Some examples of typical loss leaders include milk, eggs, rice, and other inexpensive items that grocers
wouldn't want to sell without other purchases.
Examples
The razor and blades business model, pioneered by American businessman King C. Gillette, is similar to the
loss leader business model. Razor handles are given away for free or sold at a loss, but sales of disposable
razor blades are very profitable. Since the late 1990s, this model has proven very popular and successful
for inkjet printer manufacturers, where profit is derived from the sale of expensive ink cartridges.
In 1910, the City of Pasadena criticized the private Edison Gas and Electric Company for giving away free
electric lamps to solicit new electricity subscribers.
[6]

In 1979, American businessman Earl Muntz decided to sell blank tapes and VCRs as loss leaders to attract
customers to his showroom, where he would then try to sell them highly profitable widescreen projection TV
systems of his own design. His success continued through the early 1980s.
[7]

Inkjet and laser printers are also often sold to retail customers below their margin price and could also be
viewed as loss leaders. Some of the printers, especially the entry-level models, are sold at a loss-leading price
which seems apparently affordable to most consumers, but they pay the regular price for ink cartridges or
toner, and specialty papers supplied by the manufacturer. The manufacturer also limits the customers' options
by not supporting third party ink, including refills. This analysis more closely parallels the strategies of tying and
bundling products, however. A disadvantage to this model is the waste caused when the printers are priced
below the refills, causing savvy consumers to treat their printers as disposable and replace them every time
they run out.
Loss leaders can be an important part of companies' marketing and sales strategies, especially
during dumping campaigns.
Video game consoles have often been sold at a loss while software and accessory sales are highly profitable to
the console manufacturer, a tactic first utilized in the sixth generation era. Sony and Microsoft, with
their PlayStation 2 and Xbox, had prohibitively high manufacturing costs so they were forced to sell their
consoles at a loss, and these losses widened especially in 20022003 when both sides tried to grab market
share with price cuts. Nintendo had a different strategy with its GameCube, which was considerably less
expensive to produce than its rivals, so it retailed at break-even or higher prices. In the current generation of
consoles; both Sony and Microsoft have sold their consoles, the Playstation 3 and Xbox 360, respectively, at a
loss and made up for it through game software and accessory profits (Nintendo again prices its Wii at break-
even or higher prices, as it is cheaper to make). For this reason, console manufacturers aggressively protect
their profit margin against piracy by pursuing legal action against carriers of modchips and jailbreaks.
Dangers
In recent years, loss leader pricing has been practiced with considerable success, especially by large national
discount retailers. The strategy is not without controversy, however. Indeed, many states have passed laws
that severely limit or explicitly forbid selling products below cost. Lawsuits alleging that some loss leader pricing
strategies amount to illegal business practices have increased in recent years, though the plaintiffs have not
always been victorious. Opponents of loss leading pricing practices argue that the strategy is basically
predatory in nature, designed to ultimately force competitors out of business.



















Penetration pricing

Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than
the eventual market price, to attract new customers. The strategy works on the expectation that customers
will switch to the new brand because of the lower price. Penetration pricing is most commonly associated
with a marketing objective of increasing market share or sales volume, rather than to make profit in the
short term.
The advantages of penetration pricing to the firm are:
It can result in fast diffusion and adoption. This can achieve high market penetration rates quickly. This
can take the competition by surprise, not giving them time to react.
It can create goodwill among the early adopters segment. This can create more trade through word of
mouth.
It creates cost control and cost reduction pressures from the start, leading to greater efficiency.
It discourages the entry of competitors. Low prices act as a barrier to entry (see Porter's 5-forces
analysis).
It can create high stock turnover throughout the distribution channel. This can create critically
important enthusiasm and support in the channel.
It can be based on marginal cost pricing, which is economically efficient.
The main disadvantage with penetration pricing is that it establishes long term price expectations for
the product, and image preconceptions for the brand and company. This makes it difficult to eventually
raise prices. Some commentators claim that penetration pricing attracts only the switchers (bargain
hunters), and that they will switch away as soon as the price rises. There is much controversy over
whether it is better to raise prices gradually over a period of years (so that consumers dont notice), or
employ a single large price increase. A common solution to this problem is to set the initial price at the long
term market price, but include an initial discount coupon (see sales promotion). In this way, the
perceived price points remain high even though the actual selling price is low.
Another potential disadvantage is that the low profit margins may not be sustainable long enough for the
strategy to be effective.
Price Penetration is most appropriate where:
Product demand is highly price elastic.
Substantial economies of scale are available.
The product is suitable for a mass market (i.e. enough demand).
The product will face stiff competition soon after introduction.
There is not enough demand amongst consumers to make price skimming work.
In industries where standardization is important. The product that achieves high market penetration
often becomes the industry standard (e.g. Microsoft Windows) and other products, whatever their
merits, become marginalized. Standards carry heavy momentum.
A variant of the price penetration strategy is the bait and hook model (also called the razor and blades
business model), where a starter product is sold at a very low price but requires more expensive
replacements (such as refills) which are sold at a higher price. This is an almost universal tactic in the
desktop printer business, with printers selling in the US for as little as $100 including two ink cartridges
(often half-full), which themselves cost around $30 each to replace. Thus the company makes more
money from the cartridges than it does for the printer itself.
Taken to the extreme, penetration pricing becomes predatory pricing, when a firm initially sells a product or
service at unsustainably low prices to eliminate competition and establish a monopoly. In most countries,
predatory pricing is illegal, although it can be difficult to differentiate illegal predatory pricing from legal
penetration pricing.













Price discrimination
From Wikipedia, the free encyclopedia
Price discrimination or price differentiation
[1]
exists when sales of identical goods or services are transacted
at different prices from the same provider.
[2]
In a theoretical market with perfect information, perfect substitutes,
and no transaction costs or prohibition on secondary exchange (or re-selling) to prevent arbitrage, price
discrimination can only be a feature of monopolistic and oligopolistic markets,
[3]
where market power can be
exercised. Otherwise, the moment the seller tries to sell the same good at different prices, the buyer at the
lower price can arbitrage by selling to the consumer buying at the higher price but with a tiny discount.
However, product heterogeneity, market frictions or high fixed costs (which make marginal-cost pricing
unsustainable in the long run) can allow for some degree of differential pricing to different consumers, even in
fully competitive retail or industrial markets. Price discrimination also occurs when the same price is charged to
customers which have different supply costs.
The effects of price discrimination on social efficiency are unclear; typically such behavior leads to lower prices
for some consumers and higher prices for others. Output can be expanded when price discrimination is very
efficient, but output can also decline when discrimination is more effective at extracting surplus from high-
valued users than expanding sales to low valued users. Even if output remains constant, price discrimination
can reduce efficiency by misallocating output among consumers.
Price discrimination requires market segmentation and some means to discourage discount customers from
becoming resellers and, by extension, competitors. This usually entails using one or more means of preventing
any resale, keeping the different price groups separate, making price comparisons difficult, or restricting pricing
information. The boundary set up by the marketer to keep segments separate are referred to as a rate fence.
Price discrimination is thus very common in services where resale is not possible; an example is student
discounts at museums. Price discrimination in intellectual property is also enforced by law and by technology.
In the market for DVDs, DVD players are designed - by law - with chips to prevent an inexpensive copy of the
DVD (for example legally purchased in India) from being used in a higher price market (like the US). The Digital
Millennium Copyright Act has provisions to outlaw circumventing of such devices to protect the enhanced
monopoly profits that copyright holders can obtain from price discrimination against higher price market
segments.
Price discrimination can also be seen where the requirement that goods be identical is relaxed. For example,
so-called "premium products" (including relatively simple products, such as cappuccino compared to regular
coffee) have a price differential that is not explained by the cost of production. Some economists have argued
that this is a form of price discrimination exercised by providing a means for consumers to reveal their
willingness to pay.
Types of price discrimination
First degree price discrimination
This type of price discrimination is primarily theoretical because it requires the seller of a good or service to
know the absolute maximum price (or reservation price) that every consumer is willing to pay. By knowing the
reservation price, the seller is able to absorb the entire market surplus, thus taking all of the consumer's
surplus from the consumer and transforming it into revenues. From a social welfare perspective though, first
degree price discrimination is not necessarily undesirable. That is, the market is entirely efficient and there is
no deadweight loss to society. In a market with first degree price discrimination, the seller(s) simply captures all
surplus. This type of market does not exist much in reality, hence it is primarily theoretical. Examples of where
this might be observed are in markets where consumers bid for tenders, though still, in this case, the practice
of collusive tendering undermines efficiency.
Second degree price discrimination
In second degree price discrimination, price varies according to quantity sold. Larger quantities are available
at a lower unit price. This is particularly widespread in sales to industrial customers, where bulk buyers enjoy
higher discounts.
Additionally to second degree price discrimination, sellers are not able to differentiate between different
types of consumers. Thus, the suppliers will provide incentives for the consumers to differentiate themselves
according to preference. As above, quantity "discounts", or non-linear pricing, is a means by which suppliers
use consumer preference to distinguish classes of consumers. This allows the supplier to set different prices to
the different groups and capture a larger portion of the total market surplus.
In reality, different pricing may apply to differences in product quality as well as quantity. For example, airlines
often offer multiple classes of seats on flights, such as first class and economy class. This is a way to
differentiate consumers based on preference, and therefore allows the airline to capture more consumer's
surplus.
Third degree price discrimination
In third degree price discrimination, price varies by attributes such as location or by customer segment, or in
the most extreme case, by the individual customer's identity; where the attribute in question is used as a proxy
for ability/willingness to pay.
Additionally to third degree price discrimination, the supplier(s) of a market where this type of discrimination
is exhibited are capable of differentiating between consumer classes. Examples of this differentiation are
student or senior discounts. For example, a student or a senior consumer will have a different willingness to
pay than an average consumer, where the reservation price is presumably lower because of budget
constraints. Thus, the supplier sets a lower price for that consumer because the student or senior has a more
elastic Price elasticity of demand (see the discussion of Price elasticity of demand as it applies to revenues
from the first degree price discrimination, above). The supplier is once again capable of capturing more market
surplus than would be possible without price discrimination.
Note that it is not always advantageous to the company to price discriminate even if it is possible, especially for
second and third degree discrimination. In some circumstances, the demands of different classes of consumers
will encourage suppliers to ignore one or more classes and target entirely to the rest. Whether it is profitable to
price discriminate is determined by the specifics of a particular market.
Fourth degree price discrimination
In fourth degree price discrimination, prices are the same for different customers, however costs to the
organization may vary. For example, one may buy a plane ticket, but call ahead to order a vegetarian meal,
possibly costing the company more to provide, but your ticket has no greater cost to you. This is also known as
reverse price discrimination, as the effects are reflected on the producer.
Combination
These types are not mutually exclusive. Thus a company may vary pricing by location, but then offer bulk
discounts as well. Airlines use several different types of price discrimination, including:
Bulk discounts to wholesalers, consolidators, and tour operators
Incentive discounts for higher sales volumes to travel agents and corporate buyers
Seasonal discounts, incentive discounts, and even general prices that vary by location. The price of a flight
from say, Singapore to Beijing can vary widely if one buys the ticket in Singapore compared to Beijing (or
New York or Tokyo or elsewhere).
Discounted tickets requiring advance purchase and/or Saturday stays. Both restrictions have the effect of
excluding business travelers, who typically travel during the workweek and arrange trips on shorter notice.
First degree price discrimination based on customer. It is not accidental that hotel or car rental firms may
quote higher prices to their loyalty program's top tier members than to the general public.
[citation needed]

Modern taxonomy
The first/second/third degree taxonomy of price discrimination is due to Pigou (Economics of Welfare, 4th
edition, 1932). See, e.g., modern taxonomy of price discrimination. However, these categories are not mutually
exclusive or exhaustive. Ivan Png (Managerial Economics, 2nd edition, 2002) suggests an alternative
taxonomy:
Complete discrimination -- where each user purchases up to the point where the user's marginal benefit
equals the marginal cost of the item;
Direct segmentation -- where the seller can condition price on some attribute (like age or gender)
that directly segments the buyers;
Indirect segmentation -- where the seller relies on some proxy (e.g., package size, usage quantity,
coupon) to structure a choice that indirectly segments the buyers.
The hierarchycomplete/direct/indirectis in decreasing order of
profitability and
information requirement.
Complete price discrimination is most profitable, and requires the seller to have the most information about
buyers. Indirect segmentation is least profitable, and requires the seller to have the least information about
buyers.
Two part tariff
the two part tariff is another form of price discrimination where the producer charges an initial fee then a
secondary fee for the use of the product, an example of this is razors, you pay an initial cost for the Gillet razor
and then pay for the replacement blades, this pricing strategy works because it shifts the demand curve to the
right since you have already paid for the initial blade holder you will buy the blades which are now cheaper than
buying a disposable razor, the formulea for profit from a two part tariff is =PQ+nT-C1(Q)-C2(n) where is
profit P is price Q is quantity n is number of customers (who pay tariff) C is cost
so re written it is = (price x quantity + number of people x tariff) - the cost of producing that quantity - the cost of
producing the tariff (blade holders)
Explanation


Sales revenue without and with Price Discrimination
The purpose of price discrimination is generally to capture the market's consumer surplus. This surplus arises
because, in a market with a single clearing price, some customers (the very low price elasticity segment) would
have been prepared to pay more than the single market price. Price discrimination transfers some of this
surplus from the consumer to the producer/marketer. Strictly, a consumer surplus need not exist, for example
where some below-cost selling is beneficial due to fixed costs or economies of scale. An example is a high-
speed internet connection shared by two consumers in a single building; if one is willing to pay less than half
the cost, and the other willing to make up the rest but not to pay the entire cost, then price discrimination is
necessary for the purchase to take place.
It can be proved mathematically that a firm facing a downward sloping demand curve that is convex to the
origin will always obtain higher revenues under price discrimination than under a single price strategy. This can
also be shown diagrammatically.
In the top diagram, a single price (P) is available to all customers. The amount of revenue is represented by
area P, A, Q, O. The consumer surplus is the area above line segment P, A but below the demand curve (D).
With price discrimination, (the bottom diagram), the demand curve is divided into two segments (D1 and D2). A
higher price (P1) is charged to the low elasticity segment, and a lower price (P2) is charged to the high
elasticity segment. The total revenue from the first segment is equal to the area P1,B, Q1,O. The total revenue
from the second segment is equal to the area E, C,Q2,Q1. The sum of these areas will always be greater than
the area without discrimination assuming the demand curve resembles a rectangular hyperbola with unitary
elasticity. The more prices that are introduced, the greater the sum of the revenue areas, and the more of the
consumer surplus is captured by the producer.
Note that the above requires both first and second degree price discrimination: the right segment corresponds
partly to different people than the left segment, partly to the same people, willing to buy more if the product is
cheaper.
It is very useful for the price discriminator to determine the optimum prices in each market segment. This is
done in the next diagram where each segment is considered as a separate market with its own demand curve.
As usual, the profit maximizing output (Qt) is determined by the intersection of the marginal cost curve (MC)
with the marginal revenue curve for the total market (MRt).


Multiple Market Price Determination
The firm decides what amount of the total output to sell in each market by looking at the intersection of
marginal cost with marginal revenue (profit maximization). This output is then divided between the two markets,
at the equilibrium marginal revenue level. Therefore, the optimum outputs are Qa and Qb. From the demand
curve in each market we can determine the profit maximizing prices of Pa and Pb.
It is also important to note that the marginal revenue in both markets at the optimal output levels must be equal,
otherwise the firm could profit from transferring output over to whichever market is offering higher marginal
revenue.
Given that Market 1 has a price elasticity of demand of E1 and Market of E2, the optimal pricing ration in
Market 1 versus Market 2 is .
Examples of price discrimination
Retail price discrimination
In certain circumstances, it is a violation of the Robinson-Patman Act, (a 1936 Federal U.S. antitrust statute) for
manufacturers of goods to sell their products to similarly situated retailers at different prices based solely on the
volume of products purchased.
Travel industry
Airlines and other travel companies use differentiated pricing regularly, as they sell travel products and services
simultaneously to different market segments. This is often done by assigning capacity to various booking
classes, which sell for different prices and which may be linked to fare restrictions. The restrictions or "fences"
help ensure that market segments buy in the booking class range that has been established for them. For
example, schedule-sensitive business passengers who are willing to pay $300 for a seat from city A to city B
cannot purchase a $150 ticket because the $150 booking class contains a requirement for a Saturday night
stay, or a 15-day advance purchase, or another fare rule that discourages, minimizes, or effectively prevents a
sale to business passengers.
Notice however that in this example "the seat" is not really always the same product. That is, the business
person who purchases the $300 ticket may be willing to do so in return for a seat on a high-demand morning
flight, for full refundability if the ticket is not used, and for the ability to upgrade to first class if space is available
for a nominal fee. On the same flight are price-sensitive passengers who are not willing to pay $300, but who
are willing to fly on a lower-demand flight (say one leaving an hour earlier), or via a connection city (not a non-
stop flight), and who are willing to forgo refundability.
On the other hand, an airline may also apply differential pricing to "the same seat" over time, e.g. by
discounting the price for an early or late booking (without changing any other fare condition). This could present
an arbitrage opportunity in the absence of any restriction on reselling. However, passenger name changes are
typically prevented or financially penalized by contract.
Since airlines often fly multi-leg flights, and since no-show rates vary by segment, competition for the seat has
to take in the spatial dynamics of the product. Someone trying to fly A-B is competing with people trying to fly
A-C through city B on the same aircraft. This is one reason airlines use yield management technology to
determine how many seats to allot for A-B passengers, B-C passengers, and A-B-C passengers, at their
varying fares and with varying demands and no-show rates.
With the rise of the Internet and the growth of low fare airlines, airfare pricing transparency has become far
more pronounced. Passengers discovered it is quite easy to compare fares across different flights or different
airlines. This helped put pressure on airlines to lower fares. Meanwhile, in the recession following the
September 11, 2001, attacks on the U.S., business travelers and corporate buyers made it clear to airlines that
they were not going to be buying air travel at rates high enough to subsidize lower fares for non-business
travelers. This prediction has come true, as vast numbers of business travelers are buying airfares only in
economy class for business travel.
There are sometimes group discounts on rail tickets and passes. This may be in view of the alternative of going
by car together.
Coupons
The use of coupons in retail is an attempt to distinguish customers by their reserve price. The assumption is
that people who go through the trouble of collecting coupons have greater price sensitivity than those who do
not. Thus, making coupons available enables, for instance, breakfast cereal makers to charge higher prices to
price-insensitive customers, while still making some profit off customers who are more price-sensitive.
Premium pricing
For certain products, premium products are priced at a level (compared to "regular" or "economy" products)
that is well beyond their marginal cost of production. For example, a coffee chain may price regular coffee at
$1, but "premium" coffee at $2.50 (where the respective costs of production may be $0.90 and $1.25).
Economists such as Tim Harford in the Undercover Economist have argued that this is a form of price
discrimination: by providing a choice between a regular and premium product, consumers are being asked to
reveal their degree of price sensitivity (or willingness to pay) for comparable products. Similar techniques are
used in pricing business class airline tickets and premium alcoholic drinks, for example.
This effect can lead to (seemingly) perverse incentives for the producer. If, for example, potential business
class customers will pay a large price differential only if economy class seats are uncomfortable while economy
class customers are more sensitive to price than comfort, airlines may have substantial incentives to purposely
make economy seating uncomfortable. In the example of coffee, a restaurant may gain more economic profit
by making poor quality regular coffeemore profit is gained from up-selling to premium customers than is lost
from customers who refuse to purchase inexpensive but poor quality coffee. In such cases, the net social utility
should also account for the "lost" utility to consumers of the regular product, although determining the
magnitude of this foregone utility may not be feasible.
Segmentation by age group and student status
Many movie theaters, amusement parks, tourist attractions, and other places have different admission prices
per market segment: typical groupings are Youth, Student, Adult, and Senior. Each of these groups typically
have a much different demand curve. Children, people living on student wages, and people living on retirement
generally have much less disposable income.
Discounts for members of certain occupations
Many businesses, especially in the Southern United States, offer reduced prices to active military members. In
addition to increased sales to the target group, businesses benefit from the resulting positive publicity, leading
to increased sales to the general public. Less publicized are discounts to other service workers such as police;
off-duty police customers in high-crime areas are said to constitute free security.
[citation needed]

Employee discounts
Most people feel that discounts businesses give to their own employees are an employee benefit (and is often
listed as such in the employee handbook). However, some might construe this as a form of price discrimination.
Retail incentives
A variety of incentive techniques may be used to increase market share or revenues at the retail level. These
include discount coupons, rebates, bulk and quantity pricing, seasonal discounts, and frequent buyer discounts.
Incentives for industrial buyers
Many methods exist to incentivize wholesale or industrial buyers. These may be quite targeted, as they are
designed to generate specific activity, such as buying more frequently, buying more regularly, buying in bigger
quantities, buying new products with established ones, and so on. Thus, there are bulk discounts, special
pricing for long-term commitments, non-peak discounts, discounts on high-demand goods to incentivize buying
lower-demand goods, rebates, and many others. This can help the relations between the firms involved.
Sex-based examples
Many sex-based price differences are held to be illegal but still occur often in countries such as the United
States and the United Kingdom.
Ladies' night"
Many North American and European nightclubs feature a "ladies' night" in which women are offered discount or
free drinks, or are absolved from payment of cover charges. This differs from conventional price discrimination
in that the primary motive is not, usually, to increase revenue at the expense of consumer surplus, but to
increase the club's attractiveness to the market side more willing to pay (men), for the benefit of the other
(women). (See also two-sided market)
Dry cleaning
Dry cleaners typically charge higher prices for the laundering of women's clothes than for men's. Some US
communities have reacted by outlawing the practice. Dry cleaners justify the price differences because
women's clothes typically require far more time to press than men's clothes due to more pleating. This qualifies
an example of price discrimination if at least part of the reason for the higher pricing is really the dry cleaner's
belief that women will be willing to pay more than men.
Haircutting
Women's haircuts are often more expensive than men's haircuts because women generally have longer, more
complex hairstyles whereas men generally have shorter hairstyles. Some salons have modified their pricing to
reflect "long hair" versus "short hair" or style instead of sex. This situation has been common practice in barber
shops for decades.
Automobile Insurance
Males have traditionally been charged higher rates than women for automobile insurance, and much higher
rates for under-30s. This disparity is especially prevalent for males under the age of 25.
Financial aid in education
Financial aid as offered by U.S. colleges and universities is a form of price discrimination that is widely
accepted, and completely legal.
Haggling
Many cultures involve haggling in market transactions inflated prices are posted, but the customer can
negotiate with the vendor. In the United States, haggling is rare to non-existent in retail, but common
when automobiles and homes are sold. Negotiation often requires knowledge, confidence, and the ability to
manage confrontational personalities, and vendors know that many customers will pay higher prices in order to
avoid negotiating.
International price discrimination
Pharmaceutical companies may charge customers living in wealthier countries (such as the United States) a
much higher price than for identical drugs in poorer nations, as is the case with the sale of anti-retroviral drugs
in Africa. Since the purchasing power of African consumers is much lower, sales would be extremely limited
without price discrimination. The ability of pharmaceutical companies to maintain price differences between
countries is often either reinforced or hindered by national drugs laws and regulations, or the lack thereof.
Although not common in modern times, governments have traditionally raised revenues from tariffs. When
these are not flat tariffs, the government effectively sets the prices of goods that are not produced locally and
are only imported.
Even online sales for non material goods, which do not have to be shipped, may change according to the
geographic location of the buyer. A song in Apple's iTunes costs 79 pence (1.49 USD) for Britons but only 99
cents for Americans. (~50% more for the same song) These differences may arise because of changes
in exchange rates that occur much more frequently than changes in prices, or they may arise because the
license-holders (in this case, record companies) are enforcing their existing pricing policy on new licensees or
intermediaries.
Academic pricing
Companies will often offer discounted software to students and faculty at K-12 and university levels. These may
be labeled as academic versions, but perform the same as the full price retail software. Academic versions of
the most expensive software suites may be priced as little as one fifth or less of retail price. Some academic
software may have differing licenses than retail versions, usually disallowing their use in activities for profit or
expiring the license after a given number of months. This also has the characteristics of an "initial offer" - that
is, the profits from an academic customer may come partly in the form of future non-academic sales due
to vendor lock-in. For example, an accounting student buys academically priced Microsoft Excel, and as a
result of getting used to it, continues to use it throughout a future career, the future editions of which he buys at
full price, instead of moving to the fully compatible OpenOffice.org equivalent application.
Dual pricing
Even within a country, differentiated pricing may be established to ensure that citizens receive lower prices
than non-citizens; this is known as dual pricing. This is particularly common for goods that are subsidized or
otherwise provided by the state (and hence paid by taxpayers). Thus, in places such
as Switzerland, Finland, Thailand, and India, citizens may purchase special fare tickets for public transportation
that are available only to citizens. Many countries also maintain separate admission charges for museums,
national parks and similar facilities, the usually professed reason being that citizens should be able to educate
themselves and enjoy the country's natural wonders cheaply, but other visitors should pay the market rate.
Certain places in Thailand will often have one price for tourists and another for native Thais. The Grand
Palace in Bangkok, for example, charges admission to foreign tourists, but Thai citizens are allowed free entry.
Many publicly run universities in the United States are subsidized by taxpayers of the state in which they are
located; residents of said state are frequently given a discount on tuition as a result.
Wage discrimination
Wage discrimination is when the price of equivalent labor is discriminated among different groups of workers.
This may be seen as just one kind of price discrimination or as an example of its inverse, one buyer buying
identical goods at different rates.
Universal pricing
Universal pricing is the opposite of price discrimination one price is offered for the good or service. This is
usually preferred by consumers over tiered pricing.
[citation needed]
For example, the European Union is currently
making efforts to set a single-price protocol for automobile sales.
[citation needed]

Two necessary conditions for price discrimination
There are two conditions that must be met if a price discrimination scheme is to work. First the firm must be
able to identify market segments by their price elasticity of demand and second the firms must be able to
enforce the scheme.
[4]
For example, airlines routinely engage in price discrimination by charging high prices for
customers with relatively inelastic demand - business travelers - and discount prices for tourist who have
relatively elastic demand. The airlines enforce the scheme by making the tickets non-transferable thus
preventing a tourist from buying a ticket at a discounted price and selling it to a business traveler (arbitrage).
Airlines must also prevent business travelers from directly buying discount tickets. Airlines accomplish this by
imposing advance ticketing requirements or minimum stay requirements conditions that would be difficult for
average business traveler to meet.
[5]

User-controlled price discrimination
While the conventional theory of price discrimination generally assumes that prices are set by the seller, there
is a variant form in which prices are set by the buyer, such as in the form of pay what you want pricing. Such
user-controlled price discrimination exploits similar ability to adapt to varying demand curves or individual price
sensitivities, and may avoid the negative perceptions of price discrimination as imposed by a seller.



Premium pricing
Premium pricing is the practice of keeping the price of a product or service artificially high in order to
encourage favorable perceptions among buyers, based solely on the price.
[1]
The practice is intended to exploit
the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional
reputation or represent exceptional quality and distinction.
Strategic considerations
The use of premium pricing as either a marketing strategy or a competitive practice depends on certain factors
that influence its profitability and sustainability. The disadvantages of this pricing strategy includes Such factors
include:
Information asymmetry (e.g., when buyers have no independent basis to test claims of "exceptional
quality" for a particular product or service -- assuming the concept is well-defined to begin with);
Market status as a Luxury good or a Superior good; and
Market dynamics such as the level of competition and entry barriers.

Predatory pricing
In business and economics, predatory pricing is the practice of selling a product or service at a very low price,
intending to drive competitors out of the market, or create barriers to entry for potential new competitors. If
competitors or potential competitors cannot sustain equal or lower prices without losing money, they go out of
business or choose not to enter the business. The predatory merchant then has fewer competitors or is even
a de facto monopoly, and hypothetically could then raise prices above what the market would otherwise bear.
In many countries predatory pricing is considered anti-competitive and is illegal under competition laws. It is
usually difficult to prove that prices dropped because of deliberate predatory pricing rather than legitimate price
competition. In any case, competitors may be driven out of the market before the case is ever heard.

Concept
In the short term predatory pricing through sharp discounting reduces profit margins, as would a price war, and
will cause profits to fall. There are various tests to assess whether the pricing is predatory: Areeda-Turner
suggest it is below Short Run Marginal Costs, the AKZO case suggests it is costing below Average Variable
Costs, and the case of United Brands suggests it is simply when the difference in cost between the cost of
manufacturing and the price charged to consumers is excessive. Yet businesses may engage in predatory
pricing as a longer term strategy. Competitors who are not as financially stable or strong may suffer even
greater loss of revenue or reduced profits. After the weaker competitors are driven out, the surviving business
can raise prices above competitive levels (to supra competitive pricing). The predator hopes to generate
revenues and profits in the future that will more than offset the losses it incurred during the predatory pricing
period. This is known as recoupment, but two recent decisions by the courts, Tetra Pak II and Wanadoo stated
that this is not necessary for a finding of predatory pricing.
In essence, the predator undergoes short-term pain for long-term gain. Therefore, for the predator to succeed,
it must have sufficient strength (financial reserves, guaranteed backing or other sources of offsetting revenue)
to endure the initial lean period. There must be substantial barriers to entry for new competitors.
But the strategy may fail if competitors are stronger than expected, or are driven out but replaced by others. In
either case, this forces the predator to prolong or abandon the price reductions. The strategy may thus fail if the
predator cannot endure the short-term losses, either because of it requiring longer than expected or simply
because it did not estimate the loss well.
So the predator should hope this strategy to succeed only when it is substantially stronger than its competitors
and when barriers to entry are high. The barriers prevent new entrants to the market replacing others driven
out, thereby allowing supra competitive pricing to prevail long enough to dwarf the initial loss.
Legal aspects
In many countries there are legal restrictions for using this pricing strategy, which may be deemed anti-
competitive. It may not be de facto illegal, but have severe restrictions.


Australia
Recent amendments to the Trade Practices Act 1974 in 2007 created a new threshold test to prohibit those
engaging in predatory pricing. The amendments, labelled the 'Birdsville Amendments' after Senator Barnaby
Joyce, penned the idea
[1]
in s46 to define the practice more liberally than other behaviour by requiring the
business first to have a 'substantial share of a market' (rather than substantial market power). This was made in
a move to protect smaller businesses from situations where there are larger players, but each has market
power. It has been criticised as preventingthrough legal
Canada
Section 50 of the Competition Act, which criminalized predatory pricing, has been repealed.
[2]

It was replaced by sections 78 and 79 which deal with the matters civilly. Section 78(1)(i) of the Competition Act
prohibits companies from the selling products at unreasonably low prices which is either designed to facilitate,
or has the effect of, eliminating competition or a competitor. The Competition Bureau has established Predatory
Pricing Guidelines defining what is considered to be unreasonably low pricing.
United States
Predatory pricing practices may result in antitrust claims of monopolization or attempts to monopolize.
Businesses with dominant or substantial market shares are more vulnerable to antitrust claims. However,
because the antitrust laws are ultimately intended to benefit consumers, and discounting results in at least
short-term net benefit to consumers, the U.S. Supreme Court has set high hurdles to antitrust claims based on
a predatory pricing theory. The Court requires plaintiffs to show a likelihood that the pricing practices will affect
not only rivals but also competition in the market as a whole, in order to establish that there is a substantial
probability of success of the attempt to monopolize.
[3]
If there is a likelihood that market entrants will prevent the
predator from recouping its investment through supra competitive pricing, then there is no probability of
success and the antitrust claim would fail. In addition, the Court established that for prices to be predatory, they
must be below the seller's cost.
Criticism
Some economists claim that true predatory pricing is rare because it is an irrational practice and that laws
designed to prevent it only inhibit competition. This stance was taken by the US Supreme Court in the 1993
case Brooke Group v. Brown & Williamson Tobacco, and the Federal Trade Commission has not successfully
prosecuted any company for predatory pricing since.
In addition, the predator's competitors know that it cannot keep its prices down forever, and thus need only play
chicken to remain in the market, assuming they have the means to do so.
Thomas Sowell explains one reason why predatory pricing is unlikely to work:
Obviously, predatory pricing pays off only if the surviving predator can then raise prices enough to
recover the previous losses, making enough extra profit thereafter to justify the risks. These risks are
not small.
However, even the demise of a competitor does not leave the survivor home free. Bankruptcy does not
by itself destroy the fallen competitor's physical plant or the people whose skills made it a viable
business. Both may be available-perhaps at distress prices-to others who can spring up to take the
defunct firm's place.
The Washington Post went bankrupt in 1933, though not because of predatory pricing. But neither its
physical plant, its people, or its name disappeared into thin air. Instead, publisher Eugene Meyer
acquired all three-at a fraction of what he had bid unsuccessfully for the same newspaper just four
years earlier. In the course of time, the Post became the biggest newspaper in Washington.
[4]

Critics of laws against predatory pricing may support their case empirically by arguing that there
has been no instance where such a practice has actually led to a monopoly. Conversely, they
argue that there is much evidence that predatory pricing has failed miserably. For
example, Herbert Dow not only found a cheaper way to produce bromine but also defeated a
predatory pricing attempt by the government-supported German cartel Bromkonvention, who
objected to his selling in Germany at a lower price. Bromkonvention retaliated by flooding the US
market with below-cost bromine, at an even lower price than Dow's. But Dow simply instructed
his agents to buy up at the very low price, then sell it back in Germany at a profit but still lower
than Bromkonvention's price. In the end, the cartel could not keep up selling below cost, and had
to give in. This is used as evidence that the free market is a better way to stop predatory pricing
than regulations such as anti-trust laws.
In another example of a successful defense against predatory pricing, a price war emerged
between the NYCR and the Erie Railroad. At one point, NYCR charged only a dollar per car for
the transport of cattle. While the cattle cars quickly filled up, management were dismayed to find
that Erie Railroad had also invested in the cattle-haulage business.
[5]

Sowell argues:
It is a commentary on the development of antitrust law that the accused must defend himself, not
against actual evidence of wrongdoing, but against a theory which predicts wrongdoing in the future. It
is the civil equivalent of "preventive detention" in criminal casespunishment without proof.
[4]




Support
Increasing production and lowering prices below costs, a firm may convince its competitors
that it has achieved a lower cost of production than they competitors may be led to believe
the firm has high volume and low costs and may therefore believe it is not below cost but
rather reflects greater business efficiency. It could lead them to conclude that competing
would not be profitable.
[citation needed]
This is known as low-cost signaling. Eventually a small
competitor may not have the resources to stay in business if a larger predator continues
predatory pricing for long enough.
[citation needed]
However, this only suggests that a company
might be able to successfully price other firms out of the marketthere is no evidence to
support the theory that the virtual monopoly could then raise prices, for as soon as they did
that, other firms would rapidly be able to enter the market and compete.
[6]
Anyhow most of
outsiders are afraid to entering monopolized market
[citation needed]
. Such entering demands a lot
of capital investments, which would not be repaid soon due to sharp decreasing of prices at
the market provoked by resumption of competition.
[7][8]
Another serious barriers to entering at
the monopolized market, such as using by monopolies an intellectual property (patent
protection), production and technological experience effect (first-mover advantage), high
buyer switching costs (for example a lot of PC users are still use Microsoft products that
switching to an alternative product would create significant costs for them) and control of key
inputs and technologies (for example, power grids by power generating
monopolies)
[8]
usually making monopolised markets very complicated for outsiders in
properties of Laissez-faire capitalism.
Examples of alleged predatory pricing
Standard Oil Company - In 1909, the US Department of Justice sued Standard under
federal anti-trust law, the Sherman Antitrust Act of 1890, for sustaining a monopoly and
restraining interstate commerce. The government said that Standard raised prices to its
monopolistic customers but lowered them to hurt competitors, often disguising its illegal
actions by using bogus supposedly independent companies it controlled.
"The evidence is, in fact, absolutely conclusive that the Standard Oil Company
charges altogether excessive prices where it meets no competition, and particularly
where there is little likelihood of competitors entering the field, and that, on the other
hand, where competition is active, it frequently cuts prices to a point which leaves
even the Standard little or no profit, and which more often leaves no profit to the
competitor, whose costs are ordinarily somewhat higher."
[9]

France Telecom/WanadooThe European Court of Justice judged that Wanadoo (Now
Orange Internet France) charged less than cost in order to gain a lead in the French
broadband market. They have been ordered to pay a fine of 10.35m, although this can
still be contested.
[10]

Microsoft released their web-browser Internet Explorer for free. As a result the market
leader and primary competitor, Netscape, was forced to release Netscape Navigator for
free in order to stay in the market. Internet Explorer's free inclusion in Windows led to it
quickly becoming the web browser used by most computer users.
[11]

According to an AP article
[12]
a law in Minnesota forced Wal-Mart to increase its price for
a one month supply of the prescription birth control pill Tri-Sprintec from $9.00 to
$26.88.
According to a New York Times article
[13]
the German government ordered Wal-Mart to
increase its prices.
According to an International Herald Tribune article,
[14]
the French government
ordered amazon.com to stop offering free shipping to its customers, because it was in
violation of French predatory pricing laws. After Amazon refused to obey the order, the
government proceeded to fine them 1,000 per day. Amazon continued to pay the fines
instead of ending its policy of offering free shipping.
Low oil prices during the 1990s, while being financially unsustainable, effectively stifled
exploration to increase production, delayed innovation of alternative energy sources and
eliminated competition from other more expensive yet productive sources of petroleum
such as stripper wells.
[citation needed]

In the Darlington Bus War, Stagecoach Group offered free bus rides in order to put the
rival Darlington Corporation Transport out of business.

Contribution margin-based pricing
Contribution margin-based pricing maximizes the profit derived from an individual product, based on the
difference between the product's price and variable costs (the product's contribution margin per unit), and on
ones assumptions regarding the relationship between the products price and the number of units that can be
sold at that price. The product's contribution to total firm profit (i.e., to operating income) is maximized when a
price is chosen that maximizes the following:
Contribution Margin Per Unit X Number of Units Sold
Contribution margin per unit is the difference between the price of a product and the sum of the variable costs
of one unit of that product. Variable costs are all costs that will increase with greater unit sales of a product or
decrease with fewer unit sales (i.e., leaving out fixed costs, which are costs that will not change with sales level
over an assumed possible range of sales levels). Examples of variable costs are raw materials, direct labor (if
such costs vary with sales levels), and sales commissions.
[1]

The contribution margin per unit of each product multiplied by units sold equals the contribution to profit from
sales of that product.
The total of Contributions to Profit from all a firms products minus the firms fixed costs equals the firms profit
(more precisely, operating income).
To express the above in mathematical format:
Price - Variable Costs Per Unit = Contribution Margin Per Unit

Contribution Margin Per Unit x Units Sold = Products Contribution to Profit

Contributions to Profit From All Products Firms Fixed Costs = Total Firm
Profit
Therefore, using the simplified example of a single-product firm, a firm would maximize profit by determining
the price that maximizes contribution to profit (i.e., contribution margin per unit multiplied by the number of units
sold), since the fixed costs that will next be subtracted will, by definition, be a constant regardless of the
number of units sold.
Assuming an inverse relationship between price and units sold (i.e., sales volume), as is the case for most
products since a lower price will generally induce higher unit sales, the firm would assume likely unit sales
levels at various price levels, calculate the contribution margin per unit for the product at each of those price
levels, multiply the number of units by the corresponding Contribution Margin Per Unit at that price level and
choose the highest result (i.e., the highest Contribution to Profit) to maximize profit.
Note that this approach determines the price that maximizes profit only for an individual product, and only over
a given time horizon. There are other factors a firm must consider in setting the price for each product (i.e.,
factors other than profit-maximization for that product alone), particularly if they have multiple products. Some
(but not all) of these other factors are:
Impact on sales of other products of the firm (complementary sales; cannibalization; impact on brand
image; impact on distribution or trade push of the firms other products; competitor reaction affecting the
firms other products).
The strategic role of the product and others in the product portfolio (price points and positioning of the
other products; each products role in the firms cash flow).
Plans to replace or modify the product (and hold distribution in the meantime).
Economies of scale and scope, and experience curve effects on costs.
Long-term strategy for the product.











Psychological pricing




Example of psychological pricing at a gas station

Psychological pricing or price ending is a marketing practice based on the theory that certain prices have
a psychological impact. The retail prices are often expressed as "odd prices": a little less than a round number,
e.g. $19.99 or 2.98. The theory is this drives demand greater than would be expected if consumers
were perfectly rational. Psychological pricing is one cause of price points.

Overview
According to a 1997 study published in the Marketing Bulletin, approximately 60% of prices in advertising
material ended in the digit 9, 30% ended in the digit 5, 7% ended in the digit 0 and the remaining seven digits
combined accounted for only slightly over 3% of prices evaluated.
[1]
In the UK, before the withdrawal of
the halfpenny coin in 1969, prices often ended in 11
1

2
d (elevenpence halfpenny: just under a shilling, which
was 12d). This is still seen today in gasoline (petrol) pricing ending in
9

10
of the local currency's smallest
denomination; for example in the US the price of a gallon of gasoline almost always ends in US$0.009 (e.g.
US$3.289).
Digit
ending
Proportion in the 1997
Marketing Bulletin study
0 7.5%
1 0.3%
2 0.3%
3 0.8%
4 0.3%
5 28.6%
6 0.3%
7 0.4%
8 1.0%
9 60.7%
In a traditional cash transaction, fractional pricing imposes tangible costs on the vendor (printing fractional
prices), the cashier (producing awkward change) and the customer (stowing the change). These factors have
become less relevant with the increased use of checks, credit and debit cards and other forms of currency-free
exchange; also, the addition of sales tax makes the pre-tax price less relevant to the amount of change
(although in Europe the sales tax is generally included in the shelf price).
The psychological pricing theory is based on one or more of the following hypotheses:
Consumers ignore the least significant digits rather than do the proper rounding. Even though the cents
are seen and not totally ignored, they may subconsciously be partially ignored. Some
[who?]
suggest that this
effect may be enhanced when the cents are printed smaller (for example, $19
99
).
Fractional prices suggest to consumers that goods are marked at the lowest possible price.
When items are listed in a way that is segregated into price bands (such as an online real estate search),
price ending is used to keep an item in a lower band, to be seen by more potential purchasers.
Judgments of numerical differences are anchored on left-most digits, a behavioral phenomenon referred to
as the left-digit anchoring effect (see Thomas and Morwitz 2005). This hypothesis suggests that people
perceive the difference between 1.99 and 3.00 to be closer to 2.01 than to 1.01 because their judgments
are anchored on the left-most digit.
The theory of psychological pricing is controversial. Some studies show that buyers, even young children, have
a very sophisticated understanding of true cost and relative value and that, to the limits of the accuracy of the
test, they behave rationally. Other researchers claim that this ignores the non-rational nature of the
phenomenon and that acceptance of the theory requires belief in a subconscious level of thought processes, a
belief that economic models tend to deny or ignore. Research using results from modern scanner data is
mixed.
Now that many customers are used to odd pricing, some restaurants and high-end retailers psychologically-
price in even numbers in an attempt to reinforce their brand image of quality and sophistication.
Research
Kaushik Basu used game theory in 1997 to argue that rational consumers value their own time and effort at
calculation. Such consumers process the price from left to right and tend to mentally replace the last two digits
of the price with an estimate of the mean "cent component" of all goods in the marketplace. In a sufficiently
large marketplace, this implies that any individual seller can charge the largest possible "cent component" (99)
without significantly affecting the average of cent components and without changing customer behavior.
[2]

The euro introduction in 2002, with its various exchange rates, distorted existing nominal price patterns while at
the same time retaining real prices. A European wide study (el Sehity, Hoelzl and Kirchler, 2005) investigated
consumer price digits before and after the euro introduction for price adjustments. The research showed a clear
trend towards psychological pricing after the transition. Further, Benford's Law as a benchmark for the
investigation of price digits was successfully introduced into the context of pricing. The importance of this
benchmark for detecting irregularities in prices was demonstrated and with it a clear trend towards
psychological pricing after the nominal shock of the euro introduction.
[3]

Another phenomenon noted by economists is that a price point for a product (such as $4.99) remains stable for
a long period of time, with companies slowly reducing the quantity of product in the package until consumers
begin to notice. At this time the price will increase marginally (to $5.05) and then within an exceptionally short
time will increase to the next price point ($5.99, for example).
[4]

Research has also found psychological pricing relevant for the study of politics and public policy.
[5]
For
instance, a study of Danish municipal income taxes found evidence of "odd taxation" as tax rates with a nine-
ending were found to be over-represented compared to other end-decimals.
[6]

Historical comments
Exactly how psychological pricing came into common use is not clear, though it is known the practice arose
during the late 19th century. One source speculates it originated in a newspaper pricing competition. Melville E.
Stone founded the Chicago Daily News in 1875, intending to price it at one cent to compete with
the nickel papers of the day. The story claims that pennies were not common currency at the time, and so
Stone colluded with advertisers to set whole dollar prices a cent lowerthus guaranteeing that customers
would receive ample pennies in change.
[7]

Others have suggested that fractional pricing was first adopted as a control on employee theft. For cash
transactions with a round price, there is a chance that a dishonest cashier will pocket the bill rather than record
the sale. For cash transactions with an odd price, the cashier must make change for the customer. This
generally means opening the cash register which creates a record of the sale in the register and reduces the
risk of the cashier stealing from the store owner.
[citation needed]

In the former Czechoslovakia, people called this pricing "baovsk cena" ("Baa's price"), referring to Tom
Baa, a Czech manufacturer of footwear. He began to widely use this practice in 1920.
[8]

Price ending has also been used by retailers to highlight sale or clearance items for administrative purposes. A
retailer might end all regular prices in 95 and all sale price in 50. This makes it easy for a buyer to identify
which items are discounted when looking at a report.
[citation needed]

In its 2005 United Kingdom general election manifesto, the Official Monster Raving Loony Party proposed the
introduction of a 99-pence coin to "save on change".
[9]

Wal-Mart, a major retailer, makes use of .98 price endings as opposed to .99 endings.
A recent trend in some monetary systems is to eliminate the smallest denomination coin (typically 0.01 of the
local currency). The total cost of purchased items is then rounded up/down to, for example, the nearest 0.05.
This may have an effect on future "odd-number" pricing to maximize the rounding advantage for vendors by
favoring 98 and 99 endings (rounded up) over 96 and 97 ending (rounded down) especially at small retail
outlets where single item purchases are more common. Australia is a good example of this practice where 5
cents has been the smallest denomination coin since 1992, but pricing at .98/.99 on items under several
hundred dollars is still almost universally applied (e.g.: $1.99 $299.99) while goods on sale often price at .94
and its variations. It is also the case in Finland, the only country using the euro currency which does not use the
1 and 2 cent coins.



Time-based pricing

Time-based pricing refers to a type offer or contract by a provider of a service or supplier of a commodity, in
which the price depends on the time when the service is provided or the commodity is delivered. The rational
background of time-based pricing is expected or observed change of thesupply and demand balance during
time. Time-based pricing includes fixed time-of use rates for electricity and public transport, dynamic
pricing reflecting current supply-demand situation or differentiated offers for delivery of a commodity
depending on the date of delivery (futures contract). Most often time-based pricing refers to a specific practice
of a supplier.
Time-based pricing is the standard method of pricing in the tourist industry. Higher prices are charged during
the peak season, or during special-event periods. In the off-season, hotels may charge only the operating costs
of the establishment, whereas investments and any profit are gained during the high season. (This is the basic
principle of the long run marginal cost (LRMC) pricing, see also Long run). Time based pricing is occasionally
used by transportation service providers, whereby higher prices are charged during rush-hours, or,
alternatively, some type of reduced-rate tickets are invalid at that time.
Time-based pricing of services such as provision of electric power includes, but is not limited to:
[1]

time-of-use pricing (TOU pricing), whereby electricity prices are set for a specific time period on an
advance or forward basis, typically not changing more often than twice a year. Prices paid for energy
consumed during these periods are preestablished and known to consumers in advance, allowing them to
vary their usage in response to such prices and manage their energy costs by shifting usage to a lower
cost period or reducing their consumption overall;
critical peak pricing whereby time-of-use prices are in effect except for certain peak days, when prices
may reflect the costs of generating and/or purchasing electricity at the wholesale level
real-time pricing (also: dynamic pricing) whereby electricity prices may change as often as hourly
(exceptionally more often). Price signal is provided to the user on an advanced or forward basis, reflecting
the utilitys cost of generating and/or purchasing electricity at the wholesale level; and
peak load reduction credits for consumers with large loads who enter into pre-established peak load
reduction agreements that reduce a utilitys planned capacity obligations.
Time-based pricing is recommendable for utilities both in regulated or market based environment. The use of
time-based pricing is limited in case of low difference between peak- and off-peak demand, unavailability of
adequate time-of-use metering. Also, customer response to time-based pricing should be considered
(see: Demand response).
A regulated utility will develop a time-based pricing schedule on analysis of its cost on a long-run basis,
including both operation and investment costs. A utility operating in a market environment, where electricity (or
other service) is auctioned on a competitive market, time-based pricing will reflect the price variations on the
market. Such variations include both regular oscillations due to the demand pattern of users, supply issues
(such as availability of intermittent natural resources: water flow, wind), and occasional exceptional price peaks.
Price peaks reflect strained conditions on the market (possibly augmented by market manipulation,
see: California electricity crisis) and convey possible lack of investment.


Tacit collusion

Tacit collusion occurs when cartels are illegal or overt collusion is absent. Put another way, two firms agree to
play a certain strategy without explicitly saying so. Oligopolists usually try not to engage in price cutting,
excessive advertising or other forms of competition. Thus, there may be unwritten rules of collusive behavior
such as price leadership (tacit collusion). A price leader will then emerge and sets the general industry price,
with other firms following suit. For example see the case of British Salt Limited and New Cheshire Salt Works
Limited
[1]
.

Duopoly Example
Tacit collusion is best understood in the context of a duopoly and the concept of Game Theory (namely, Nash
Equilibrium). Let's take an example of two firms A and B, who both play an advertising game over an indefinite
number of periods (effectively saying 'infinitely many'). Both of the firms' payoffs are contingent upon their own
action, but more importantly the action of their competitor. They can choose to stay at the current level of
advertising or choose a more aggressive advertising strategy. If either firm chooses low advertising while the
other chooses high, then the low-advertising firm will suffer a great loss in market share while the other
experiences a boost. However if they both choose high advertising, then neither firms' market share will
increase but their advertising costs will increase, thus lowering their profits. If they both choose to stay at the
normal level of advertising, then sales will remain constant without the added advertising expense. Thus, both
firms will experience a greater payoff if they both choose normal advertising (however this set of actions is
unstable, as both are tempted to defect to higher advertising to increase payoffs). Apayoff matrix is presented
with numbers given:

Firm B normal advertising Firm B aggressive advertising
Firm A normal advertising Each earns $50 profit
Firm A: $0 profit
Firm B: $80 profit
Firm A aggressive advertising
Firm A: $80 profit
Firm B: $0 profit
Each earns $15 profit
Notice that Nash's Equilibrium is set at both firms choosing an aggressive advertising strategy. This is to
protect themselves against lost sales.
In general, if the payoffs for colluding (normal, normal) are greater than the payoffs for cheating (aggressive,
aggressive), then the two firms will want to collude (tacitly). Although this collusive arrangement is not an
equilibrium in the one-shot game above, repeating the game allows the firms to sustain collusion over long time
periods. This can be achied, for example if each firm's strategy is to undertake normal advertising so long as its
rival does likewise, and to pursue aggressive advertising forever as soon as its rival has used an aggressive
advertising campaign at least once (this threat is credible since symmetric use of aggressive advertising is a
Nash equilibrium of each stage of the game). Each firm must then weigh the short term gain of $30 from
'cheating' against the long term loss of $35 in all future periods that comes as part of its punishment. Provided
that firms care enough about the future, collusion is an equilibrium of this repeated game.
To be more precise, suppose that firms have a discount factor . The discounted value of the cost to
cheating and being punished indefinitely are
.
The firms therefore prefer not to cheat (so that collusion is an equilibrium) if
.
Forms
Classical economic theory holds that price stability is ideally attained at a price equal to the
incremental cost of producing additional units. Monopolies are able to extract optimum revenue by
offering fewer units at a higher cost.
An oligopoly where each firm acts independently tends toward equilibrium at the ideal, but such
covert cooperation as price leadership tends toward higher profitability for all, though it is
an unstable arrangement.
In barometric firm price leadership, the most reliable firm emerges as the best barometer of market
conditions, or the firm could be the one with the lowest costs of production, leading other firms to
follow suit. Although this firm might not be dominating the industry, its prices are believed to reflect
market conditions which are the most satisfactory, as the firm would most likely be a good forecaster
of economic changes.




Value-based pricing
Value based pricing, or Value optimized pricing is a business strategy. It sets prices primarily, but not
exclusively, on the value, perceived or estimated, to the customer rather than on the cost of the product, the
market price, competitors' prices, or historical prices.
[1]

[2]

The goal of value-based pricing is to align a price with the value delivered. It is based on the notion that a
customer receiving high levels of value will pay a higher price than a customer receiving lower levels of value
for the same product or service.
A benefit of value-based pricing strategy is its potential to increase revenue, by expanding the number of
customers served, and increasing margin growth by differentiating prices to customers. Value based pricing is
intended to make companies become more competitive and more profitable than using simpler pricing
methods. Examples of value-based pricing could include prices set based on the economic value the product or
service provides for the customer's business. Alternatively, other examples could be the number of users of a
product or the value of its use to different users, or the number of annual transactions per customer and the
value per transaction. Value-based pricing can also be used in product development and product management
to configure products to maximize value for specific types of customers or segments of customers.
Value-based pricing is predicated upon an understanding of customer value. In many settings, gaining this
understanding requires primary research. This may include evaluation of customer operations and interviews
with customer personnel. Survey methods are sometimes used to determine value a customer attributes to a
product or a service. The results of such surveys often depict a customer's 'willingness to pay.' Frameworks for
value-based pricing include Economic Value Estimation
[3]
are Relative Attribute Positioning, Van Westendorp
Price Sensitively Meter, Conjoint Analysis.
Another value pricing method uses Customer Value Research, which is Bernstein & Macias' method for gaining
the customer's perception of value through the use of both qualitative and quantitative research methods.
In healthcare
Value-based pricing is being considered
[4]
by the UK government as a way to price pharmaceuticals on
the NHS. According to proposals under consultation, the scheme would be introduced in 2013 when the current
agreement, the Pharmaceutical Price Regulation Scheme
[5]
, comes to an end. Exactly how the scheme will
operate is still being discussed



Pay what you want (pricing Stratagy)
Pay what you want is a pricing system where buyers pay any desired amount for a given commodity,
sometimes including zero. In some cases, a minimum (floor) price may be set, and/or a suggested price may
be indicated as guidance for the buyer. The buyer can also select an amount higher than the standard price for
the commodity.
[1]

[2]

Giving buyers the freedom to pay what you want may seem to not make much sense for a seller, but in some
situations it can be very successful. This is because it eliminates many disadvantages of conventional pricing. It
is obviously attractive to buyers to be able to pay whatever they want, for reasons that include eliminating fear
of whether a product is worthwhile at a given set price and the related risk of disappointment or buyer's
remorse. For sellers it obviates the challenging and sometimes costly task of setting the right price (which
may vary for different market segments). For both, it changes an adversarial conflict into a friendly exchange,
and addresses the fact that value perceptions and price sensitivities can vary widely among buyers.
[2]

In the book Smart Pricing
[2]
(p. 29), it is suggested that successful pay what you want programs are
characterized by:
1. A product with low marginal cost
2. A fair-minded customer
3. A product that can be sold credibly at a wide range of prices
4. A strong relationship between buyer and seller
5. A very competitive marketplace.
While most uses of pay what you want have been at the margins of the economy, or for special promotions,
there are emerging efforts to expand its utility to broader and more regular use, as noted in the Enhanced
Forms section below.
Variant terms include "pay what you wish," "pay what you like," "pay as you want," "pay as you wish," "pay as
you like," "pay what you will," "pay as you will." "Pay what you can" is sometimes used synonymously, but is
often more oriented to charity or socially-oriented uses, based more on ability to pay, while pay what you want
is often more broadly oriented to perceived value in combination with willingness and ability to pay.
History and commercial uses
Pay what you want has long existed on the margins of the economy, such as for tips and street performers, as
well as charities, but has been gaining breadth of interest in recent years.
[when?]
Theaters began using it for
selected nights,
[2]
and use for restaurants has been spreading, at least since its use for One World Everybody
Eats, founded in 2003 in Salt Lake City.
[3]
The restaurant is now owned by a nonprofit group that requires
customers pay at least $4 for their entree.
A major boost in awareness occurred in October 2007, when Radiohead released their seventh album, In
Rainbows, through the band's website as a digital download using this pricing system.
[4]

In December 2007, punk/metal record label Moshpit Tragedy Records became the first to operate fully under
the pay-what-you-want download system.
[5]

In 2010, Panera Bread used the system in a St. Louis, Missouri suburb, and has generated further attention by
opening more since.
[1]

Introduced during May 2010, the Humble Indie Bundle was a set of six independently developed digitally
downloadable video games which were distributed using a pay-what-you-want system (with inclusion of a
buyer-controllable charitable contribution). At the end of the sale, 1.27 million dollars had been raised. They
have since done twelve more bundle sales, generating a total of over $19 million in revenues, and securing in
April 2011 an investment of $4.7 MM by Sequoia Capital.
Pay what you want schemes are also closely related to crowdfunding.
Economics
With the prominence of the Radiohead experiment, economics and business researchers began a flurry of
studies, with particular attention to the behavioral economic aspects of pay what you wantwhat motivates
buyers to pay more than zero, and how can sellers structure the process to obtain desirable pricing levels? One
early such study (possibly the first) was the one done by Kim et. al. in January 2009
[6]
.
As pointed out by Kim,
[6]
pay what you want is a form of participative pricing, in that the buyer participates in
the pricing decision. It may also be viewed as a participative form of price discrimination. While some uses of
price discrimination have created negative reactions (and even legal restriction), the participative nature of pay
what you want inherently avoids the consumer perception of unfairness in imposed (or even hidden) prices
discrimation, since, in this case, it is the buyer who sets the price, not a seller who imposes it.
A study quantifying the significant added value of including a charitable contribution component in pay what you
want, as a way to increase buyer willingness to pay, gained coverage in the general press in 2010.
[7]

Enhanced Forms
Efforts have been made to expand on the benefits of pay what you want, to make it more useful and profitable
to sellers, while maintaining its inherent appeal to buyers.
One such enhancement is reflected in the Humble Indie Bundle, which has added a buyer-directed charity
component to further increase buyer willingness to pay. This is similar to the research study
[7]
noted above.
Another enhancement is an expanded process, called Fair Pay What You Want (FairPay), which shifts the
scope from a single transaction view, to an ongoing relationship over a series of transactions. It adds tracking
of individual buyers' reputations for paying fairly (as assessed by the seller), and uses that reputation data to
determine what further offers to extend to that individual buyer. In that way it seeks to incentivise fair pricing by
buyers (to maintain a good reputation, and thus be eligible for future offers), and to enable sellers to limit their
risk on each transaction in accord with the buyer's reputation.



Freemium
Freemium is a business model by which a product or service (typically a digital offering such as software,
media, games or web services) is provided free of charge, but a premium is charged for advanced features,
functionality, or virtual goods.
[1][2]
The word "freemium" is a portmanteaucombining the two aspects of the
business model: "free" and "premium".

Origin
The business model has probably been in use for software since the 1980s, particularly in the form of a free
time- or feature-limited ('lite') version, often given away on a floppy disk or CD-ROM, to promote a paid-for full
version. The model is particularly suited to software as the manufacturing cost is negligible, so as long as
significant cannibalization is avoided little is lost by giving it away for free.
However, this term for the model appears to have been created only much later, in response to a 2006 blog
post by venture capitalist Fred Wilson summarizing the model:
[3]

Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very
efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced
value added services or an enhanced version of your service to your customer base.
Jarid Lukin of Alacra then suggested the term "freemium" for this model.
[4]
The term has since appeared
in Wired magazine and Business 2.0, which has since been used by bloggers such as Chris
Anderson and Tom Evslin. In 2009, Anderson published the book Free, which examines the popularity of this
business model. As well as for traditional software and services, it is now also often used by Web 2.0 and open
source companies.
[5]

As explained by several of the references cited above, freemium is closely related to tiered services. It has
become a highly popular model, with notable success, such as quite prominently in LinkedIn,
[6]
and in the form
of a "soft" paywall, such as those launched by The New York Times,
[7]
and by Press+.
[8]
Alternative models for
monetizing digital offerings, noted in "See also", include Pay what you want, which also loosens conventional
pricing constraints. Badoo is an international dating and discovery site that also uses the model.
[9]

Restrictions
Ways in which the product or service may be restricted in the free version include:
[10]

Feature limited (e.g. a "lite" version of software, such as Skype)
Time limited (e.g. only usable for 30 days, such as Microsoft Office)
Capacity limited (e.g. for an accounts package, can only be used to read a limited number of article,
Harvard Business Review)
Seat limited (e.g. only usable on 1 computer rather than across a network)
Customer class limited (e.g. only usable by educational users)
Effort Limited (e.g. all or most features are available for free, but require extended unlocking which can be
shortcut for a fee, such as some software for virtual printing on pdf)


Premium pricing
From Wikipedia, the free encyclopedia
Premium pricing is the practice of keeping the price of a product or service artificially high in order to
encourage favorable perceptions among buyers, based solely on the price.
[1]
The practice is intended to exploit
the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional
reputation or represent exceptional quality and distinction.
Strategic considerations
The use of premium pricing as either a marketing strategy or a competitive practice depends on certain factors
that influence its profitability and sustainability. The disadvantages of this pricing strategy includes Such factors
include:
Information asymmetry (e.g., when buyers have no independent basis to test claims of "exceptional
quality" for a particular product or service -- assuming the concept is well-defined to begin with);
Market status as a Luxury good or a Superior good; and
Market dynamics such as the level of competition and entry barriers.