Pricing Strategies

1
 The
The price
price and
and quantity
quantity of
of goods
goods available
available in
in aa market
market
are
are determined
determined by
by the
the demand
demand for
for the
the good
good and
and the
the
supply
supply of
of aa good
good available
available at
at any
any given
given time.
time.

What is Price:
• Narrowly, price is the amount of money charged for a product or service.
• Broadly, price is the sum of all the values that consumers exchange for the
benefits of having or using the product or service.
Introduction
 We need to set price when we have:
a new product, or
 when we enter a new market with an existing product.
 How?
 Need to decide what position you want your product to be in
 Static Analysis - assumes that competitors will not react to how a firm
prices its products
 Dynamic Analysis - assumes that competitors will react to changes in
prices of a firm’s products
 Static is very unrealistic.
 The Internet had influenced dynamic pricing in two ways:
 Decreased menu costs - cost to change the price

 Interactivity - ease of Internet interaction

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Key Principles
 Consumers are heterogeneous in their willingness to pay
 Charge according to consumer price sensitivity. Make sure that people
with inelastic demand pay more and people with elastic demand pay less.
 Make sure that prices directed at one segment cannot be taken advantage
of by the other.

 How should you achieve this?

 Identify a “bad” for the high willingness to pay segment and bundle it with
the product to create a product for the low segment
 This is where product design and pricing comes together.

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The Seven Deadly Sins of Pricing

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Price-Quality Strategies
 Philip Kotler identified 9 price-quality strategies

High Price Low Price

High Quality High Super
Premium
Value Value

Over Mid Good

Charging Value Value

False
Rip-off Economy
Economy
Low Quality 6
The Pricing Pentagon

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Pricing Process
 Set Pricing Objectives
 Analyze demand - Differentiate value relative to
substitute products
 Draw conclusions from competitive intelligence
-Strategically select target customers segments
 Select pricing strategy appropriate to the political,
social, legal and economical environment - Predict
strategic pricing/competitive reaction
 Determine specific prices - Select a pricing structure
and price point.
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Possible Pricing Objectives

 Profit objectives
 Targeted profit return

 Volume objectives
 Dollar or unit sales growth
 Market share growth

 Other objectives
 Match competitors’ price
 Non-price competition

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Demand Analysis
 Measure the impact of price change on total
revenue
 Predicts unit sales volume and total revenue
for various price levels
 Different customers have different price
sensitivities and needs

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Impact of Cost on Pricing Strategy
 Fixed and variable costs
 Full-Cost Pricing
 Markup pricing, break-even pricing and rate-of-return
pricing
 Variable-cost pricing
 3 types of relationships
 Ratio of fixed costs to variable costs
 Economies of scales
 Cost structure

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Price determination and managerial objectives
Prices serve three broad functions:
1. Prices raise revenue for the firm.
2. Prices act as a rationing device.
3. Prices indicate changes in the wants of consumers and induce suppliers
to alter product accordingly.

• Pricing is key to managerial decision making

• Firms with market power can raise prices without losing all customers.
• A firm has market power when it faces a downward sloping demand curve.
• Firms wish to capture as much consumer surplus as possible.
• Firms achieve a target rate of return, target market share, stabilize output and match
the competition.

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Factors Affecting Pricing Decisions
Customer Value Perceptions

Effective, customer-oriented
pricing involves understanding
how much value consumers
place on the benefits they
receive from the product and
setting a price that captures
that value.
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Value-Based Pricing Vs. Cost-Based Pricing
Good-Value Pricing and Value-Added Pricing

 Good-Value Pricing:
 Offering just the right combination of quality and good service
at a fair price.
 Value-Added Pricing:
 Attaching value-added features and services to differentiate a
marketing and offer and support higher prices, rather than
cutting prices to match competitors.

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Discussion: Impact of Ethics on Pricing
 How should you price if your product is a life-
saving drug?
 What are the ethical considerations?
 Customers have no choice
 Need to pay for the research
 When cheaper options doesn’t work
 Competition decides

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 Segmented demand, heterogeneous goods

 Not a “demand curve”

Price
for a homogeneous Luxury
commodity, but
segmented markets for
Sports
related but very different
products
 Product made & priced
for one target income Midrange
group/taste pattern; very
hard to shift demand. Standard
 Can’t do it just by
reducing price… Economy

Quantity
Product differentiation limits sales because…
• Cannot reduce costs with an increase in production or without
having to face increased marketing expenses.
• Main constraint on sales is not “conditions of supply” but
“conditions of demand”
• Unlimited wants and Scarce resources.
• Not “waste” but “opportunity”
• In growing economy, new factory must have much more
capacity than needed now.
• In uncertain world, excess capacity needed to react to
opportunities 19
Choose a Price Strategy

Price
Price Skimming
Skimming

Basic Strategies
for Penetration
Setting Prices PenetrationPricing
Pricing

Status
StatusQuo
QuoPricing
Pricing

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Price Skimming
Inelastic Demand

Superior Product
Situations
When
Price Legal Protection of Product
Skimming
Is Successful
Technological Breakthrough

Limited Production

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New-Product Pricing Strategies
Market-skimming pricing is a strategy with high initial prices to
“skim” revenue layers from the market
 Product quality and image must support the price
 Buyers must want the product at the price
 Costs of producing the product in small volume should not cancel the
advantage of higher prices
 Competitors should not be able to enter the market easily

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Penetration Pricing

Price-sensitive market
Situations
When
Penetration
Pricing Elastic Demand
Is Successful

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New-Product Pricing Strategies
Market-penetration pricing sets a low initial price in order to penetrate the
market quickly and deeply to attract a large number of buyers quickly to gain
market share
 Price sensitive market

 Inverse relationship of production and distribution cost to sales growth

 Low prices must keep competition out of the market

When to use:
•Elastic demand
•Economies of scale
•Threat of strong competition

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 Status Quo Pricing

Small firm
Situations
When
Status Quo
Pricing
Is Successful Price Leader

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Product Mix Pricing Strategies

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 Product Mix Pricing Strategies

Product line pricing takes into account the cost differences between products in
the line, customer evaluation of their features, and competitors’ prices

Optional-product pricing takes into account optional or accessory products

along with the main product

Captive-product pricing involves products that must be used along with the
main product
Two-part pricing involves breaking the price into:
Fixed fee
Variable usage fee

By-product pricing refers to products with little or no value produced as a result

of the main product. Producers will seek little or no profit other than the cost to
cover storage and delivery.
Product bundle pricing combines several products at a reduced price

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Price-Adjustment Strategies

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 Price-Adjustment

Discount and allowance pricing reduces prices to rewardStrategies

customer responses
such as paying early or promoting the product – Discounts, Allowances

Segmented pricing is used when a company sells a product at two or more prices
even though the difference is not based on cost
To be effective:
• Market must be segmentable
• Segments must show different degrees of demand
• Watching the market cannot exceed the extra revenue obtained from the price
difference
• Must be legal

Psychological pricing occurs when sellers consider the psychology of prices

and not simply the economics

Reference prices are prices that buyers carry in their minds and refer to when
looking at a given product
•Noting current prices
•Remembering past prices
•Assessing the buying situations
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 Price-Adjustment Strategies

Promotional pricing is when prices are temporarily priced below list price or
cost to increase demand
•Loss leaders
•Special event pricing
•Cash rebates
•Low-interest financing
•Longer warrantees
•Free maintenance
Risks of promotional pricing:
• Used too frequently, and copies by competitors can create “deal-prone”
customers who will wait for promotions and avoid buying at regular price
• Creates price wars

Geographical pricing is used for customers in different parts of the country -world
•FOB-origin pricing
•Uniformed-delivered pricing
•Zone pricing
•Basing-point pricing
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•Freight-absorption pricing
Geographical pricing Price-Adjustment Strategies
FOB-origin (free on board) pricing means that the goods are delivered to the
carrier and the title and responsibility passes to the customer.
Uniformed-delivered pricing means the company charges the same price plus
freight to all customers, regardless of location.
Zone pricing means that the company sets up two or more zones where customers
within a given zone pay a single total price
Basing-point pricing means that a seller selects a given city as a “basing point” and
charges all customers the freight cost associated from that city to the customer
location, regardless of the city from which the goods are actually shipped
Freight-absorption pricing means the seller absorbs all or part of the actual
freight charge as an incentive to attract business in competitive markets

Dynamic pricing is when prices are adjusted continually to meet the

characteristics and needs of the individual customer and situations
International pricing is when prices are set in a specific country based on
country-specific factors:
•Economic conditions & Competitive conditions
•Laws and regulations & Infrastructure
•Company marketing objective
Price Changes

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Price Changes
Initiating Pricing Changes
 Price cuts is a reduction in selling price.
 Excess capacity
 Increase market share
 Price increases is an increase in selling price
 Cost inflation
 Increased demand and lack of supply
Buyers’ Interpretation to Price Changes
 Price cuts
 New models will be available
 Models are not selling well
 Quality issues
 Price increases
 Product is “hot”
 Company greed
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Price Changes
Responding to Price Changes
 Questions
 Why did the competitor change the price?
 Is the price cut permanent or temporary?
 What is the effect on market share and profits?
 Will competitors respond?
 Solutions
 Reduce price to match competition
 Maintain price but raise the perceived value through
communications
 Improve quality and increase price
 Launch a lower-price “fighting brand”
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 Competitor Price Cuts

Financial
Financial Trouble
Trouble
Decreasing

Decreasing prices
prices may
may be
be aa
desperate
desperate attempt
attempt to
to raise
raise cash,
cash,
or
or signal
signal to
to competitors
competitors an an
interest in being acquired
interest in being acquired

Attempting
Attempting to
to Become
Become
Typical motives for an
an Industry
Industry Leader
Leader
price cutting: Decreasing

Decreasing prices
prices is
is sometimes
sometimes
aa show
show of of strength
strength to to indicate
indicate
that
that aa firm
firm is
is doing
doing well
well enough
enough
to
to withstand
withstand the the lower
lower prices
prices

Signaling
Signaling Displeasure
Displeasure Over
Over aa
Competitor’s
Competitor’s Strategy
Strategy
A

A firm
firm can
can use
use aa price
price cut
cut to
to
punish
punish aa competitor
competitor for
for aa change
change
in
in its
its strategy
strategy
Price Changes

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 Estimate Competitor Response

Select potential prices

• Pick at least three

potential prices
Game out
• Must be prices that the competitors reactions
firm could actually
charge
• Do industry research to
brief managers before
game Estimate revised price
• Construct a scenario-
planning exercise
• Use game results to
• Use a multiperiod
estimate both the firm’s
game for best results
final price as well as
competitors’ price points
Legality and Ethics of Price Strategy

Price
Price Fixing
Fixing

Price
Price Discrimination
Discrimination

Issues
Issues
That
That Limit
Limit
Pricing
Pricing
Decisions
Decisions Predatory
Predatory Pricing
Pricing
 Legality and Ethics of Price Strategy

Price fixing: Sellers must set prices without talking to competitors

Price Discrimination
 Charge different prices to different customers
 Transaction must occur in interstate commerce
 Seller must make two/ more sales w/in short time period
 Commodities of like grade and quality
 Must be significant competitive injury
 Sellers can argue price variations 
 Different Costs
 Different Market Conditions
 Competition

Predatory Pricing
• Selling below cost with the intention of punishing a competitor or gaining higher
long-term profits by putting competitors out of business
Price Discrimination
With price discrimination,
discrimination a firm sets two or more distinct prices for
a product. Higher prices are for inelastic segments and lower
prices for elastic ones.
 Customer-based price discrimination—Prices differ by customer
category for the same good or service.
 Product-based price discrimination—A firm markets a number
of features, styles, qualities, brands, or sizes of a product and sets
a different price for each product version.
 Time-based price discrimination—A firm varies prices by day
versus evening, time of day, or season.
 Place-based price discrimination—Prices differ by seat location,
floor location, or geographic location.
 When a firm engages in price discrimination, it should use yield
management pricing—whereby it determines the mix of price-
quantity combinations that generates the highest revenues for a
given time. 40
Price Discrimination

First
First Degree
Degree—— Charge
Charge
consumers
consumers exactly
exactly what
whatthey
they
are willing to pay for product
are willing to pay for product
(e.g.,
(e.g., 1–1
1–1 price
pricehaggling)
haggling)

Second
Second Degree
Degree — — Charge
Charge
consumers
consumers exactly what they
exactly what they
Price are
are willing to pay for first unitof
willing to pay for first unit of
Discrimination good
good asas well
well as
as additional
additional units
units
(e.g.,
(e.g., volume
volume pricing)
pricing)

Third
Third Degree
Degree—— Divide
Divide
consumers
consumers into intodistinct
distinct
segments,
segments, charging different
charging different
prices
pricesto to different
differentsegments
segments
(e.g.,
(e.g., movie-theater
movie-theaterpricing)
pricing)
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 Fine Tuning the Base Price

Quantity
Quantity Discounts
Discounts

Cash
Cash Discounts
Discounts

Functional
Functional Discounts
Discounts

Seasonal
Seasonal Discounts
Discounts
Common
Common
Tactics
Tactics Promotional
Promotional Allowances
Allowances
for
for
Fine-Tuning
Fine-Tuning
the
the Base
Base Price
Price Rebates
Rebates
 Special Pricing Tactics

Single-Price Tactic All goods at the same price

Flexible Pricing Different customers pay different price

Price Lining Several line items at specific price points

Loss Leader Pricing Sell product at near or below cost

Lure customers through false or misleading
Bait Pricing price advertising
Odd-number prices imply bargain
Odd-Even Pricing Even-number prices imply quality
Combining two or more products in a
Price Bundling single package
Two-Part Pricing Two separate charges to consume a single good
 Information Needed for Price Change

 Customers’ ability & willingness to buy; customer

lifestyle; benefits sought; characteristics of the
product.
 Need to know everything about the competitors
 How would competitors react to our price change?
(see following slide)
 In obtaining competitors’ information, remember the
value of the information

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New-Product Pricing Strategies
1. Skimming pricing
 Charging a high price initially and reducing the price over time
 Commonly used when introducing new & innovative products
in the ASPAC region
1. Penetration pricing
 Charging a low price when entering the market to capture
market share
 Used when competitors are closing in with similar or better
products
3. Intermediate pricing
 Pricing somewhere in between the skimming strategy and the
penetration strategy

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Pricing Strategies for Established Products

Three strategic alternatives:

1. Maintain the price if you are the leader

2. Reduce the price e.g.

3. Increase the price

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Price-Flexibility Strategy
 One-price policy—setting one fixed price
for all markets
 Flexible-price policy—setting different
prices in different markets based on:
 Geographic Location,
 Time of delivery, or
 The complexity of the product

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How much flexibility in price?

 Depends on the Demand-Cost gap and the influence of

competition, social, legal and ethical considerations
 Example: Life-saving drugs

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Product-Line Pricing
 When pricing products in different lines, must
take cross-elasticities of demand across the
set of products into consideration

 The idea is to maximize the profits of the entire

organization rather than that of a single product
or a single line

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Leasing Strategy
 Leasing is more common for industrial
goods e.g.
 Singapore Airlines sold many of their
aircraft and lease them back for their
operations
 There is a growing trend toward leasing
consumer goods as well
 e.g. Leasing of office equipment

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Reactions to Price Change
 Customers are more sensitive to price changes
if the products cost a lot and/or are bought
frequently
 Competitors may see each of your price change
as a fresh challenge and react according to its
self-interest at the time. Need to estimate each
close competitor’s likely reaction

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Responding to Competitors’ Price Change

 If competitors lower price for homogenous products

 Try augmenting the product
 If it doesn’t work or if it is not likely to work, then meet the
price cut head-on
 If competitors raise price
 In a homogeneous market, follow if you think the whole
market is likely to follow
 In a non-homogeneous market, evaluate
 The reason for the competitor price change

 If the price increase is temporary

 The effect on your market share & profit

 The likely responses from the other competitors

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When a Market Leader is Being Attacked on Price

Options available:
 Maintain price

 Raise perceived quality

 Match competitors’ price

 Increase price and improve quality

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Impact of Discounting on Brand Equity

 Why discount?

 Problems emerging with discounts

 The value equation (V=Q/P)

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Price War

Price wars are frequent in industries where

 Cost differentiation opportunities exists
 Capital is intensive and products are
homogeneous

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Yield Management

 What is it?
 Yield management goals
 Industries that benefited from yield management
 Common variables

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Will the Internet Commoditize Prices?
Point-Counterpoint
The Internet Will Lead to Price The Internet Will Not
Commoditization Commoditize Prices
 The Internet makes vast amounts of  Even if all else is equal, brand will
information available to consumers. still command a premium
As a result, markets will become  Providers are able to differentiate
more efficient, and differences in their offerings by bundling
products and pricing willdecrease products and services; consumers
 Consumers on the Internet are not will place a premium on attractive
restricted by geography when "bundles"
making their purchases, so they are  The Internet makes it possible for
free to choose among a wider consumers to create their own
range of providers and may switch products and bundles
more frequently
 The Internet offers consumers a
 On the Internet, providers have new convenient purchasing
difficulty differentiating their experience that they are willing to
products; they find it hard to pay for
compete on anything but price
 Levers & the Stages of Customer
Relationships

Exploration/
Exploration/
Awareness
Awareness Commitment
Commitment Dissolution
Dissolution
Expansion
Expansion

 Click-through  Targeted Promotions  Tiered loyalty  Discontinue pricing

promotions  Future price programs promotions
 Web-referral promotions promotions  Wide variety of  Reconfigure loyalty
 Specialty negotiated  Justify prices pricing plans programs
promotions (e.g., hotels)  Loyalty programs
 Become affiliates  Decrease profit
 Bricks-and-clicks  Profit-enhancing programs
promotions programs
 Web price discounts  Volume-discount
 Bundle promotions
 Frenzy pricing
 Targeted promotions
 Prestige
 Future price
promotions
 Price as a sign of quality
 Fairness
 Hi-Lo
 Two-part pricing
 Dynamic pricing
 EDLP
 EDLP