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Pricing Strategies and Tactics

Luiz Afonso dos Santos Senna, PhD

lsenna@producao.ufrgs.br

Luiz Afonso dos Santos Senna - PhD


Fatores na fixação de Preço

Luiz Afonso dos Santos Senna - PhD


Fatores Externos afetando as decisões de preços

Fatores Externos incluem a natureza do mercado


e da demanda, competição e outros elementos
ambientais

 Mercado e demanda
 Custos definem o limite inferior e a demanda
define o limite de preço.
 As relações preço-demanda são fuindamentais
par aos teomadres de decisão em transportes

Luiz Afonso dos Santos Senna - PhD


Preço em diferentes tipos de mercados

 Mercados de Competição Pura


 Bens/serviços uniformes
 Não existe um único vendedor ou comprador com
efeito significativo sobre o preço de mercado
 Marketing mix possui pouco impacto

Luiz Afonso dos Santos Senna - PhD


Preço em diferentes tipos de mercados

 Competição Monopolística
 Compradores e vendedores trocam sobre uma gama
de preços
 Ênfase em diferenças por meio de diferenciação
através de marketing mix
 Competição Oligopolística
 Poucos vendedores altamente sensíveis aos preços
de cada um e de estratégias de marketing

Luiz Afonso dos Santos Senna - PhD


Objetivos de Pricing

Considerações primárias na fixação de preços

Luiz Afonso dos Santos Senna - PhD


Preço baseado em custos X baseado em valor

Cost-based versus value-based pricing


Source: The Strategy and Tactics of Pricing, by Thomas T. Nagle and Reed K. Holden (2011)

Luiz Afonso dos Santos Senna - PhD


Pricing, Competição e
Estrutura de Mercado
Porter’s Five Forces Model (old)
 How does our pricing strategy fit into this
framework? What economic principles apply?

New Entrants

Supplier Power Internal Rivalry Buyer Power

Substitutes and Complements

Luiz Afonso dos Santos Senna - PhD


Market Structure – Internal rivalry
 Market structure and pricing decisions are closely
related. But how to define the market?
 The degree to which the firm gets to choose price is
determined in large part by market structure
 There are two extreme cases: perfect competition
and monopoly

Luiz Afonso dos Santos Senna - PhD


Assessing and responding to a competitor’s price cut (depending
on the market structure)
Luiz Afonso dos Santos Senna - PhD
Perfect Competition

 Conditions necessary:

 Large numbers of buyers and sellers


 Homogeneous product
 Free entry and exit
 Perfect information

Luiz Afonso dos Santos Senna - PhD


Perfect Competition
 Demand curve for any given firm is
horizontal. Price is set by market at Pe

P P D
e e
D

 Firm can sell as much or as little as desired


at market price, but nothing if they raise P.
Luiz Afonso dos Santos Senna - PhD
Monopoly
 Conditions necessary
 Single seller of product
 No close substitutes
 Significant barriers to entry
 There are few examples of perfect
competition and pure monopoly.
 Most firms have a differentiated product, and
there are substitutes.

Luiz Afonso dos Santos Senna - PhD


Pricing in Perfect Competition

 Do not choose price.


 Choose output quantity. TC includes opportunity
cost of capital invested.
 What will be our profit (loss) from our output
decision?
 Should we produce now? (SR)
 Should we stay in the industry? (LR)

Luiz Afonso dos Santos Senna - PhD


Costs at different levels of production

Cost per unit at different levels of production

Luiz Afonso dos Santos Senna - PhD


Pricing in a Monopoly

 Profit maximization will be achieved by setting


price so that MC=MR.
 It is not reached by setting price as “high as
possible.”
 Like any firm, the monopolist is constrained
by their demand curve.
 One cannot choose both P and Q.

Luiz Afonso dos Santos Senna - PhD


The Shut-Down Rule
 At what point should the firm cease
production of a certain item?
 When might it pay to produce at a loss?
 In SR, many costs are fixed. Just because a
firm is making losses, it does not necessarily
mean it should shut down (short run), or even
go out of business (long-run).

Luiz Afonso dos Santos Senna - PhD


The Shut-Down Rule cont.

 Profit = TR – TC; TR=P*Q, TC = VC + FC


 (TR - VC) - FC = [(P - AVC)Q] – FC
 Separate out fixed costs, focus on variable elements
 As long as P>AVC, there is a positive contribution to
fixed costs.
 If firm shuts down (Q = 0), then Profit = - FC
 If shut down: Firm has a loss of fixed costs.

Luiz Afonso dos Santos Senna - PhD


The Shut-Down Rule cont.

 In SR, firm may minimize losses by continuing to


produce.
 If losses are expected permanently, get out.

 Case of multiple products:

 C = FC + VC1 + VC2

Luiz Afonso dos Santos Senna - PhD


The Shut-Down Rule
1. P = (TR1 - TVC1) + (TR2 - TVC2) - FC
2. P = (P1*Q1 - AVC1*Q1) + (P2*Q2 - AVC2*Q2) - FC
3. P = [(P1 - AVC1)*Q1]+ [(P2 - AVC2)*Q2] - FC
 Results:
1. SR - each product should be produced if Pi>AVCi
2. In LR, the firm should continue operating only if
expected P>=0 (Profits are non-negative)

Luiz Afonso dos Santos Senna - PhD


Price Discrimination
 Selling the same good to different people at
different prices
 Conditions necessary:
 Identifiable customer groups with differing price
elasticities
 Maintain separation of groups--prevent resale.

Luiz Afonso dos Santos Senna - PhD


Types of Price Discrimination
 First degree
 Identify and charge each customer
what they are willing to pay
 Limit: D = MR, no consumer
surplus.
 Second degree
 Quantity discounts. Volume
purchases are given lower prices.
Need to measure goods and
services bought by consumers.
Luiz Afonso dos Santos Senna - PhD
Types of Price Discrimination
 Third degree
 Segment markets in some way. Charge
all in the segment the same prices.
 Treat each segment as a separate
market– then do MR=MC in each
 Are coupons as a price discrimination
mechanism?

Luiz Afonso dos Santos Senna - PhD


Oligopoly Strategies
 Common theme - Rivalrous behavior
 Pricing - limit pricing - set prices low as signal
to possible entrants or other competitors your
willingness and ability to defend your market
share.
 Must have credibility.
 Trading SR profit for more profits later

Luiz Afonso dos Santos Senna - PhD


Oligopoly Strategies
 Use the legal / regulatory systems
 File patent application
 Challenge business charter application
 File regulatory challenge
 Pre-emptive entry - Wal-Mart

Luiz Afonso dos Santos Senna - PhD


Oligopoly Strategies
 Capacity and production

 Announce capacity expansion


 Revise/modify products - more
difficult to copy
 Advertising

 Raise cost of entry for others

Luiz Afonso dos Santos Senna - PhD


Oligopoly and Monopolistic Competition
 Oligopoly
 Few sellers - usually large ones
 Recognized interdependence in
pricing and output decisions
 Need to consider response of rivals in
pricing decisions
 Typically significant barriers to entry

Luiz Afonso dos Santos Senna - PhD


Oligopoly and Monopolistic Competition
 Monopolistic Competition

 Large number of interdependent


sellers
 Differentiated product
 Good substitutes
 Easy entry and exit

Luiz Afonso dos Santos Senna - PhD


Oligopoly and Monopolistic Competition
 Most industries are one or the other
Oligopoly: many heavy manufacturing
Autos, steel, chemicals, pharmaceuticals
Monopolistic Competition
Service companies, retail stores, large
corporations (McDonald’s, Wendy’s)
The important point is that demand is downward
sloping

Luiz Afonso dos Santos Senna - PhD


Cartels
 Illegal in most countries – but encouraged in
others
 Conditions helpful:
 Small number of firms
 Homogeneous product
 Entry barriers
 Similarity of members

Luiz Afonso dos Santos Senna - PhD


Cartels
 Problems with cartels:
 Cheating on agreement
 Price cutting behaviour
 Tend to fall apart
 Note: When might firms in an industry ask for
(demand) regulation?

Luiz Afonso dos Santos Senna - PhD


Pricing Strategies
 Profit maximizing rule:
Set production at level where MR = MC
 Non - Maximizing pricing rules
there are a variety of these

Luiz Afonso dos Santos Senna - PhD


Pricing for Multi-Product Firm

 Two products, x and y. TRfirm = TRx + TRy


 If there are any spillovers from x to y, then you
may get complications.

dTR dTRx dTRy


MRx = = 
dQx dQx dQx
dTR dTRy dTRx
MRy = = 
dQy dQy dQy
Luiz Afonso dos Santos Senna - PhD
Multi-Product Firm cont.
 The two terms on the right side of the
equation represent interactions. They can be
either positive or negative.
 If x and y are complementary goods, the
effect is positive.
 If x and y are substitutes, the effect is
negative. One unit’s gain is the other’s loss.

Luiz Afonso dos Santos Senna - PhD


Two part pricing
 Charge P = MC
 charge a fixed fee to extract some of the
“consumer surplus”
 Examples:
 country clubs
 health clubs
 electricity providers

Luiz Afonso dos Santos Senna - PhD


Declining block pricing
 Charging different prices according to how
much is purchased
 Attempt to extract consumer surplus and
transfer value to company

Luiz Afonso dos Santos Senna - PhD


Auction pricing models
 Standard auction model
 multiple bidders compete with each other
 start at some low price, then successive bids
raise price until someone “wins”
 Dutch auction model
 start at a high price, lower it until someone bids
 ex: dutch flower auctions

 How to extract consumer surplus?

Luiz Afonso dos Santos Senna - PhD


Porter’s Five Forces Model
 How does the development of online business
affect this analytic tool? How does the Internet
change the economic principles that apply?

New Entrants

Supplier Power Internal Rivalry Buyer Power

Substitutes and Complements

Luiz Afonso dos Santos Senna - PhD


Market structure and the Internet
 Traditional industry structure paradigm?
 Structure, time and place?
 Firm size, customer access and service?
 Pricing, and reputation online
 Who is competing with whom?

Luiz Afonso dos Santos Senna - PhD


Luiz Afonso dos Santos Senna - PhD
Internet and demand issues
 Role of customer service and customer loyalty
online: e-loyalty?
 Consumer demand issues - which goods to
buy online, which in person?
 How to price online?
 Does this signal the end of the Brand?

Luiz Afonso dos Santos Senna - PhD


Pricing and the Internet

 Traditional pricing paradigm?


 Access to demand data…...
 Measurement of demand elasticities?
 Ability to conduct pricing “experiments”
 Ability to spot market changes - and
move quickly (perhaps)
 Access to bigger customer base
 Will prices be lower online?

Luiz Afonso dos Santos Senna - PhD


Firm structure and the Internet
 Are traditional firm structure concepts now
irrelevant?
 Economies of scale? Scope?
 How does this affect firm incentives to
vertically integrate (or de-integrate)?
 Central role of transaction costs…...

Luiz Afonso dos Santos Senna - PhD


The Determinants of Demand
 Demand The relationship between the
quantity of a good desired by people in a
market and the factors that affect that the
quantity desired is referred to as the
demand for the product. We can express
the demand for a product in the form
 We have some precise definitions related
to how income and prices of other goods
affect the demand for a good/service

Luiz Afonso dos Santos Senna - PhD


 Factors that we expect to affect the demand for the good include:
 Population (n)
 Price of the good (pi)
 Price of other goods (pj)
 Income (y)
 Expectations of future prices
 Tastes (T)

Luiz Afonso dos Santos Senna - PhD


Substitutes and Complements
 Two goods, x and y, are said to be substitutes if an
increase in the price of x (y) increases the demand for
good y (x) and a decrease in the price of x (y)
decreases the demand for y (x) – (Butter and
margarine)
 Two goods, x and y, are said to be complements if
an increase in the price of x (y) decreases the demand
for good y (x) and a decrease in the price of x (y)
decreases the demand for y (x) (Sugar and coffee)

Luiz Afonso dos Santos Senna - PhD


Income and Demand

 A good is said to be normal if an increase


(decrease) in income increases (decreases) the
demand for the good. A good is said to be
inferior if an increase (decrease) in income
decreases (increases) the demand for a good

Luiz Afonso dos Santos Senna - PhD


The Demand Curve

 The relationship between the quantity demanded of a good and the


price of that good is referred to as the demand curve.

Luiz Afonso dos Santos Senna - PhD


Figure 5

10

6
D
Price ($)

0
0 10 20 30 40 50 60 70 80 90 100
Quantity

Luiz Afonso dos Santos Senna - PhD


 The demand curve gives the relationship
between price and the quantity consumers
will desire to purchase at that price
 Note the demand curve is drawn given that
no other factors affecting the demand for
the product, such as income, population, or
tastes, change
 Demand for the product is based on
specific, unchanging values for the other
factors that affect demand
Luiz Afonso dos Santos Senna - PhD
The Law of Demand

 As the price of a good decreases (increases),


more (less) of it will be purchased
 That is, the demand curve is downward sloping
 There are two factors that explain this
relationship:
 As the price of a good increases, consumers will substitute into
other goods (substitution effect);
 .As the price of a good increases, consumers will have less real
income to purchase all goods (income effect).

Luiz Afonso dos Santos Senna - PhD


Changes in Demand versus Changes in Quantity
Demanded
 A movement along a demand curve is referred to as a change in
quantity demanded.
The quantity demanded changes because of a price change.

 A shift in the demand curve is referred to as a change in demand.
 Demand changes (the demand curve shifts) because of a change in
one of the factors affecting demand other than price (income, price
of other goods, tastes, population) changes.

Luiz Afonso dos Santos Senna - PhD


 Demand for steaks
D1 represents the demand for steaks (lbs/day) given the price of

chicken is $3.50; the number of customers is 1,500 a day; and the
average annual household income is $40 thousand.
 Then we might expect the following:
 A decrease in demand for steak if the price of chicken, a substitute for steak, fell
from $3.50 to $2.00.
 This is shown by a shift in of the demand curve from D1 to D2
 An increase in demand for steak if the annual income increases from $40 to $60
thousand, since steak is a normal good.
 This is shown by a shift out of the demand curve from D1 to D3

Luiz Afonso dos Santos Senna - PhD


Figure 1
10

6
D
Price ($)

0
0 10 20 30 40 50 60 70 80 90 100
Quantity

Luiz Afonso dos Santos Senna - PhD


6

D2

D3

4 D1
Price ($/lb)

D4
1

0
0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000
Luiz Afonso dos Santos Senna - PhD Quantity (lbs of Steak/Day)
Algebraic Representation

 The preceding figure that follows is given by


 QD = 100 - 10P
 Linear relationship we can graph by choosing two
points.
 Easiest points:
 Q = 0  0 = 100 - 10P or P = 10, Q = 0
 P = 0 implying Q = 100 - 10(0) = 100 and therefore
P = 0, Q = 100
 Slope, dQ/dP = -10

Luiz Afonso dos Santos Senna - PhD


The Determinants of Supply

 Number of Firms
 Price of Product
 Cost of inputs
 Wages
 Capital
 Materials
 Price of other goods
 Expectations of Future Prices
 Technology

Luiz Afonso dos Santos Senna - PhD


The Supply Curve

 The relationship between the quantity supplied of a good


and the price of that good is referred to as the supply curve
 The supply curve gives the relationship between price
and the quantity produces will wish to sell at that price
 Note the supply curve is drawn given that no other factors
affecting the supply for the product
 Supply of the product is based on specific, unchanging
values for the other factors that affect supply

Luiz Afonso dos Santos Senna - PhD


Figure 3

16

14

12
S

10

8
$

0
0 10 20 30 40 50 60 70 80
Luiz Afonso dos Santos Senna - PhD Q
The Law of Supply

 As the price of a good increases (decreases), more (less) of it will be


produced and offered for sale.
 The supply curve is upward sloping.
 This is explained by the assumption that marginal (incremental) cost
increases as output increases.

Luiz Afonso dos Santos Senna - PhD


Changes in Supply versus Changes in Quantity
Supplied
 A movement along a supply curve is referred to as a
change in quantity supplied.
 The quantity supplied changes because of a price
change.
 A shift in the supply curve is referred to as a change
in supply.
 Supply changes (the supply curve shifts) because of a
change in one of the factors affecting supply other
than price changes.

Luiz Afonso dos Santos Senna - PhD


Comparisons

 What happens to Price & Quantity when:


Incomes increase

 Wages fall
 Prices of other goods change
 Making predictions of the impact on the market of these types of
changes is referred to as Comparative Statics

Luiz Afonso dos Santos Senna - PhD


Comparisons

 These changes are all changes in demand or changes in


supply
 Shifts in demand or supply curve
 4 possibilities:
 Increase in demand (shift out demand curve)
 Decrease in demand (shift in demand curve)
 Increase in supply (shift out supply curve)
 Decrease in supply (shift in supply curve)

Luiz Afonso dos Santos Senna - PhD


The Impact of Market Condition Changes on Equilibrium Price and
Quantity
Market Impact on Impact on Examples
Change Equilibrium Equilibrium
Price Quantity
Increase in + + Increase in Income (normal
Demand good); increase in price of
substitute; decrease in price
of complements; increase in
population
Decrease - - Opposite of increase in
in Demand demand
Increase in - + Technological innovation;
Supply increase in suppliers;
decreases in costs
Decrease + - Increase in costs or wages;
in Supply increase in price of
alternative product produced
by firms

Luiz Afonso dos Santos Senna - PhD


Pricing Strategy
 How does a company decide what price to
charge for its products and services?
 What is “the price” anyway? doesn’t price
vary across situations and over time?
 Some firms have to decide what to charge
different customers and in different
situations
 They must decide whether discounts are
to be offered, to whom, when, and for what
reason
Luiz Afonso dos Santos Senna - PhD
Why is Pricing Important?
In a company with average economics*,
 1% increase in volume = 3.3% increase in
profit
 1% increase in price = 11.1% increase in
profit
 Improvements in price typically have 3-4
times the effect on profit as proportionate
increases in volume.

*Based on average of 2,463 companies


Luiz Afonso dos Santos Senna - PhD
Price vs. Nonprice Competition
 In price competition, a seller regularly offers
products priced as low as possible and
accompanied by a minimum of services
 In non price competition, a seller has
stable prices and stresses other aspects of
marketing
 With value pricing, firms strive for more
benefits at lower costs to consumer
 With relationship pricing, customers have
incentives to be loyal-- get price incentive if
you do more business with one firm

Luiz Afonso dos Santos Senna - PhD


Nonprice Competition
 Some firms feel price is the main competitive
tool, that customers always want low prices
 Other firms are looking for ways to add
value, thereby being able to avoid low prices
 Sometimes prices have to be changed in
response to competitive actions
 Many firms would prefer to engage in non
price competition by building brand equity
and relationships with customers

Luiz Afonso dos Santos Senna - PhD


The Process: An Illustration
SELECT PRICING OBJECTIVE

SELECT METHOD OF DETERMINING THE BASE PRICE:

Cost-plus Price based on Price set in


pricing both demand relation to
and costs market alone

DESIGN APPROPRIATE STRATEGIES:

Price vs. nonprice Freight payments Leader pricing


competition One price vs. Everyday low vs.
Skimming vs. flexible price high-low pricing
penetration Psychological pricing Resale price
Discounts and allowances maintenance

Luiz Afonso dos Santos Senna - PhD


Steps for Determining Prices
 Establish Pricing
Objectives
 Increase sales
volume?
 Prestigious image?
 Increase market
share?

Luiz Afonso dos Santos Senna - PhD


Steps for Determining Prices
 Study Costs
 Can you make a
profit?
 Can you reduce
costs without
affecting quality or
image?

Luiz Afonso dos Santos Senna - PhD


Steps for Determining Prices
 Estimate Demand
 What do customers
expect to pay?
 Prices usually are directly
related to demand.

Luiz Afonso dos Santos Senna - PhD


Steps for Determining Prices
 Study Competition

Luiz Afonso dos Santos Senna - PhD


Steps for Determining Prices
 Decide on a
Pricing Strategy
 Price higher than the
competition because
your product is
superior
 Price lower, then raise
it once your product is
accepted

Luiz Afonso dos Santos Senna - PhD


Steps for Determining Prices
 Set Price
 Monitor and evaluate its effectiveness
as conditions in the market change

Luiz Afonso dos Santos Senna - PhD


Pricing Technology
 Smart Pricing – decisions are based on an
enormous amount of data that Web-based
pricing technology crunches into timely, usable
information.
 Communicating Prices to Customers – electronic
gadgets that provide real-time pricing information
such as electronic shelves, digital price labels

Luiz Afonso dos Santos Senna - PhD


Pricing Technology
 RFID Technology – wireless technology that
involves tiny chips imbedded in products.
The chip has an antenna, a battery, and a
memory chip filled with a description of the
item
 Toll technology

Luiz Afonso dos Santos Senna - PhD


Geographic Considerations

 Geographic Considerations
 FOB (free on board) plant or FOB origin:
Price quotation that does not include shipping
charges. Buyer pays all freight charges to
transport the product from the manufacturer
 Freight absorption: system for handling
transportation costs under which the buyer may
deduct shipping expenses from the costs of
goods

Luiz Afonso dos Santos Senna - PhD


 Uniform-delivered price: system for handling
transportation costs under which all buyers are
quoted with the same price, including transportation
expenses
 Zone pricing: system for handling transportation
costs under which the market is divided into
geographic regions and a different price is set in
each region
 Basing-point system: system for handling
transportation costs in which the buyer’s costs
included the factory price plus freight charges from
the basing-point city nearest the buyer. Seeks to
equalize competition between distant marketers

Luiz Afonso dos Santos Senna - PhD


Product and Pricing
Strategies
Product Characteristics

Types
of Products

Stages
of Products

Luiz Afonso dos Santos Senna - PhD


Other Pricing Strategies

Price-Based

Optimization

Skimming

Penetration

Luiz Afonso dos Santos Senna - PhD


Price Adjustment Strategies

Discount Pricing

Bundling

Dynamic Pricing

Luiz Afonso dos Santos Senna - PhD


Pricing Strategies

Luiz Afonso dos Santos Senna - PhD


Penetration Pricing

Luiz Afonso dos Santos Senna - PhD


Penetration Pricing
 Price set to ‘penetrate the market’

 ‘Low’ price to secure high volumes

 Typical in mass market products – chocolate bars,


food stuffs, household goods, etc.

 Suitable for products with long anticipated life cycles


 May be useful if launching into a new market

Luiz Afonso dos Santos Senna - PhD


Market Skimming

Luiz Afonso dos Santos Senna - PhD


Market Skimming
 High price, Low volumes

 Skim the profit from the market

 Suitable for products that have


short life cycles or which will
face competition at some point
in the future (e.g. after a patent
runs out)

 Examples include: Playstation,


jewellery, digital technology,
new DVDs, etc.

Luiz Afonso dos Santos Senna - PhD


Market Skimming

Many are predicting a firesale in


laptops as supply exceeds demand
Plasma screens: Currently at
high prices but for how long?
Title: Thin-shaped television. Copyright: Getty Images,
available from Education Image Gallery

Luiz Afonso dos Santos Senna - PhD


Value Pricing

Luiz Afonso dos Santos Senna - PhD


Value Pricing
 Price set in accordance with
customer perceptions about
the value of the product /
service

 Examples include status


products/exclusive products

Companies may be able to set prices


according to perceived value.

Title: BMW At The Frankfurt Auto Show. Copyright:


Getty Images, available from Education Image Gallery

Luiz Afonso dos Santos Senna - PhD


Loss Leader

Luiz Afonso dos Santos Senna - PhD


Loss Leader
 Goods/services deliberately sold below cost to
encourage sales elsewhere

 Typical in supermarkets, e.g. at Christmas, selling


bottles of gin at £3 in the hope that people will be
attracted to the store and buy other things

 Purchases of other items more than covers ‘loss’ on


item sold
 e.g. ‘Free’ mobile phone when taking on contract
package

Luiz Afonso dos Santos Senna - PhD


Psychological Pricing

Luiz Afonso dos Santos Senna - PhD


Psychological Pricing
 Used to play on consumer perceptions

 Classic example - $9.99 instead of $10.00!

 Odd-even: $5.95, $.79, $699 OR $12, $50

 Multiple Unit-3 for !1.00 better than $.34 each

Luiz Afonso dos Santos Senna - PhD


Psychological Pricing
 Odd-Even Pricing
 Odd numbers convey a bargain
image -- $.79, $9.99, $699

 Even numbers convey a quality


image -- $10, $50, $100

Luiz Afonso dos Santos Senna - PhD


Psychological Pricing
 Prestige Pricing – sets a higher than
average price to suggest status

Luiz Afonso dos Santos Senna - PhD


Psychological Pricing
 Multiple-Unit Pricing – 3 for $.99
 Suggests a bargain and helps
increase sales volume.
 Better than selling the same items
at $.33 each.

Luiz Afonso dos Santos Senna - PhD


Psychological Pricing

Everyday Low Prices (EDLP)


– set on a consistent basis

Luiz Afonso dos Santos Senna - PhD


Going Rate (Price Leadership)

Luiz Afonso dos Santos Senna - PhD


Going Rate (Price Leadership)
 In case of price leader, rivals have difficulty in competing on
price – too high and they lose market share, too low and the
price leader would match price and force smaller rival out of
market

 May follow pricing leads of rivals especially where those rivals


have a clear dominance of market shar

 Where competition is limited, ‘going rate’ pricing may be


applicable – banks, petrol, supermarkets, electrical goods – find
very similar prices in all outlets

Luiz Afonso dos Santos Senna - PhD


Tender Pricing

Luiz Afonso dos Santos Senna - PhD


Tender Pricing
 Many contracts awarded on
a tender basis

 Firm (or firms) submit their


price for carrying out the
work

 Purchaser then chooses


which represents best value

A European consortium led by Airbus  Most government contracts


recently won a contract to supply
refuelling services to the RAF – priced
at £13 billion!

Luiz Afonso dos Santos Senna - PhD


Price Discrimination

Luiz Afonso dos Santos Senna - PhD


Price Discrimination
 Charging a different price for
the same good/service in
different markets

 Requires each market to be


impenetrable

 Requires different price


elasticity of demand in each
market
Prices for rail travel differ for the same
 Air/rail
journey at different times of the day  First class
 Business class
 Economy class

Luiz Afonso dos Santos Senna - PhD


Discounts and Allowances
 Cash Discounts – offered to
buyers to encourage them to pay
their bills quickly.
 2/10, net 30
 Quantity Discounts – offered for
placing large orders
 Trade Discounts – the way
manufacturers quote prices to
wholesalers and retailers.
Luiz Afonso dos Santos Senna - PhD
Promotional Pricing -- Used with sales
promotion
 Loss Leader Pricing – offering very
popular items for sale at below-cost
prices
 Special-Event
 Back-to-school specials
 Dollar days
 Anniversary sales
 Rebates and Coupons

Luiz Afonso dos Santos Senna - PhD


Discounts and Allowances

Seasonal Discount – offered


outside the customary buying
season

Luiz Afonso dos Santos Senna - PhD


Discounts and Allowances
 Allowances – go directly to the
buyer. Customers are offered a
price reduction if they sell back an
old model of the product they are
purchasing

Luiz Afonso dos Santos Senna - PhD


Destroyer Pricing/Predatory Pricing

Luiz Afonso dos Santos Senna - PhD


Destroyer/Predatory Pricing
 Deliberate price cutting or
offer of ‘free gifts/products’ to
force rivals (normally smaller
and weaker) out of business
or prevent new entrants

 Anti-competitive and illegal if


it can be proved

 Typical of oligopoly with


Microsoft – have been accused of predatory collusion
pricing strategies in offering ‘free’ software as
part of their operating system – Internet
Explorer and Windows Media Player - forcing
competitors like Netscape and Real Player out
of the market

Luiz Afonso dos Santos Senna - PhD


The Legality and Ethics of
Price Strategy
Unfair Trade Practices

Price Fixing

Issues Price Discrimination


That Limit
Pricing
Decisions Predatory Pricing

114
Luiz Afonso dos Santos Senna - PhD
Unfair Trade Practice Acts

Laws that prohibit


wholesalers and retailers from
selling below cost

Luiz Afonso dos Santos Senna - PhD


Price Fixing

An agreement between two or


more firms on the
price they will charge
for a product (usually in oligopolistic
markets)

Luiz Afonso dos Santos Senna - PhD


Price Discrimination
The Robinson-Patman Act of 1936 (USA):

 Prohibits any firm from selling to two or


more different buyers at different prices if
the result would lessen competition

Luiz Afonso dos Santos Senna - PhD


Robinson-Patman Act Defenses

Seller Defenses

Market
Cost Competition
Conditions

118
Luiz Afonso dos Santos Senna - PhD
Predatory Pricing

The practice of charging a


very low price for a product
with the intent of driving
competitors out of business or
out of a market.

Luiz Afonso dos Santos Senna - PhD


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

120
Luiz Afonso dos Santos Senna - PhD
Some other pricing strategies
 These all involve the use of some numerical
understanding….

Luiz Afonso dos Santos Senna - PhD


Absorption/Full Cost Pricing

Luiz Afonso dos Santos Senna - PhD


Absorption/Full Cost Pricing
 Full Cost Pricing – attempting to set price to
cover both fixed and variable costs

 Absorption Cost Pricing – Price set to


‘absorb’ some of the fixed costs of production

Luiz Afonso dos Santos Senna - PhD


Marginal Cost Pricing

Luiz Afonso dos Santos Senna - PhD


Marginal Cost Pricing
 Marginal cost – the cost of producing ONE extra or ONE fewer
item of production
 MC pricing – allows flexibility
 Particularly relevant in transport where fixed costs may be
relatively high

 Allows variable pricing structure – e.g. on a flight from London to


New York – providing the cost of the extra passenger is
covered, the price could be varied a good deal to attract
customers and fill the aircraft

Luiz Afonso dos Santos Senna - PhD


Marginal Cost Pricing
 Example:

Aircraft flying from Bristol to Edinburgh – Total Cost (including


normal profit) = £15,000 of which £13,000 is fixed cost*
Number of seats = 160, average price = £93.75
MC of each passenger = 2000/160 = £12.50
If flight not full, better to offer passengers chance of flying at
£12.50 and fill the seat than not fill it at all!
*All figures are estimates only

Luiz Afonso dos Santos Senna - PhD


Contribution Pricing

Luiz Afonso dos Santos Senna - PhD


Contribution Pricing
 Contribution = Selling Price – Variable (direct costs)
 Prices set to ensure coverage of variable costs and a
‘contribution’ to the fixed costs
 Similar in principle to marginal cost pricing
 Break-even analysis might be useful in such
circumstances

Luiz Afonso dos Santos Senna - PhD


Target Pricing

Luiz Afonso dos Santos Senna - PhD


Target Pricing
 Setting price to ‘target’ a specified profit level
 Estimates of the cost and potential revenue at
different prices, and thus the break-even
have to be made, to determine the mark-up
 Mark-up = Profit/Cost x 100

 This strategy is used by many clothes


retailers where they can add upto 60% mark-
up on the basic cost of the clothes. So even
with a 50% sales offer they still make a profit!

Luiz Afonso dos Santos Senna - PhD


Cost-Plus Pricing

Luiz Afonso dos Santos Senna - PhD


Cost-Plus Pricing
 Calculation of the average cost (AC) plus a
mark up

 AC = Total Cost/Output

Luiz Afonso dos Santos Senna - PhD


Influence of Elasticity

Luiz Afonso dos Santos Senna - PhD


Influence of Elasticity
 Price Inelastic:
 % change in Q < % change in P

 e.g. a 5% increase in price would be met by a


fall in sales of something less than 5%

 Revenue would rise

 A 7% reduction in price would lead to a rise in


sales of something less than 7%
Luiz Afonso dos Santos Senna - PhD
Influence of Elasticity
 Any pricing decision must be mindful of the impact of
price elasticity
 The degree of price elasticity impacts on the level of
sales and hence revenue
 Elasticity focuses on proportionate (percentage)
changes

 PED = % Change in Quantity demanded


% Change in Price

Luiz Afonso dos Santos Senna - PhD


Influence of Elasticity
 Price Elastic:
 % change in quantity demanded > % change in price

 e.g. A 4% rise in price would lead to sales falling by


something more than 4%

 Revenue would fall

 A 9% fall in price would lead to a rise in sales of


something more than 9%

 Revenue would rise


Luiz Afonso dos Santos Senna - PhD
Select a Pricing Method
 Mark-up Pricing - “Cost Plus”
 Target Return Pricing
 Perceived Value Pricing

137
Luiz Afonso dos Santos Senna - PhD
Device Pricing vs. Whole Product Pricing

 Value of any product to its market is strongly


influenced by prices of competitive products
 Competitive “devices” are analyzed, but
“products” are priced
 Product “features” have different values:
 Customer service
 Warranties
 Distribution channels (e.g., convenience)
 The “sum” of the features makes up the
“product”
Luiz Afonso dos Santos Senna - PhD
Determining Perceived Value

 What value is placed on the end result?


 The cost of alternative solutions to the
customer.
 A function of:
 Prices of comparable (though not identical)
products
 The “value” (+/-) of the product’s differences vs.
the competitive offering
 The value of the “Whole Product”

Luiz Afonso dos Santos Senna - PhD


Economic Value Analysis
 Identify the cost of the competitive product
or process (i.e., the reference value)
 Identify all the factors that differentiate the
product.
 Determine the value to the customer of
these differentiating factors (i.e., the
differentiation value)
 Sum the reference value and the
differentiation value to determine the total
economic value.

Luiz Afonso dos Santos Senna - PhD


Economic Value vs. Perceived Value

Product Economic Value


Performance
Marketing Effort*
Customer’s
*A key task of marketing is to translate
the economic value into high
Perceived
customer perceived value Value

Luiz Afonso dos Santos Senna - PhD


Pricing Decision
Select a Pricing Method
 Mark-up Pricing - “Cost Plus”
 Target Return Pricing
 Perceived Value Pricing
 Value Pricing
 Going Rate Pricing (market price)
 Reference Pricing (comparison w/substitutes)
 Sealed-Bid Pricing

142
Luiz Afonso dos Santos Senna - PhD
Select the Final Price

 Desired/Required Distributor Margins


 Psychological pricing
 Influence of other marketing mix elements
 Company pricing policies
 Impact of price on others

Luiz Afonso dos Santos Senna - PhD


Conjoint Analysis
Stated Preference Methods
Trade-off Analysis
and
Behavioural models

Luiz Afonso dos Santos Senna - PhD


Behavioural Models
-Logit Model-

e= basis of the logarithm neperiano


i- alternative being considered
J= set of alternatives where i is one of them
Ui= utility function of altarnative i
Uj= utility function of alternative j

Luiz Afonso dos Santos Senna - PhD


Ui = utility function
α= parameters to be estimated
Xi= attributes

Luiz Afonso dos Santos Senna - PhD


Data Collection
 Revealed Preference
 Data gained from experience
 Good to know about previous experience and
existing products/services
 Stated preference
 Data gainded from hipothetical questions in
selected scenarios
 Good to gain information about new
services/products

Luiz Afonso dos Santos Senna - PhD