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Chapter 11Module 1

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Principles of Pricing

Chapter 11

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$1,000

Your job is to buy the “best” Oriental rug. One rug is priced at $800 while another is priced at $1000. Which one is the best? How did you make that decision?

$800

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MarketingMarketingMixMix

ProductProduct PlacePlace

PromotionPromotion PricePriceWhat should we

charge?

What can we charge?

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Why care about price?

1% improvement in… operating profit improvement of…

Price

Variable Cost

Volume

Fixed Cost

11.1%

7.8%

3.3%

2.3%

The Biggest Lever the Marketer Has …

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Priceo Is the assignment of valueassignment of value, or the amount (of?) the

consumer must exchange to receive the offering.

o It is what is given (by customer) in exchange for acquiring a good or service.

o Is a mechanism used by companies to capture some of the value they have created.

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Price & Value$Price is not just a dollar figure$What are the non-monetary costs

associated with acquiring a product/service?

* TIME* CONVENIENCE* PSYCHOLOGICAL * SENSORY

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Case in point....A gym membership costs $50 per

month. What are the non-monetary “costs” associated with the

membership?* TIME* CONVENIENCE* PSYCHOLOGICAL * SENSORY

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Pricing Services is…Pricing Services is… Really HardReally Hard

Dentist Cost for Filling Distance to Dentist

Wait Period for an Appointment

Time in Waiting Room Anesthesia

AA $50 15 miles 3 Weeks 1.5 hour None

BB $75 15 miles 1 Week .5 hour Novocain

CC $125 3 miles 1 Week 1 hour Novocain

DD $200 3 miles 1 Week No wait Nitrous Oxideand Novocain

Variability

Convenience/TimeActual Price Time/ConvenienceTime/Convenience Psychological/sensory

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And not just services...And not just services...

o Do you have reference prices for any of these?• A party clown• A live Charlie Sheen Show• Whole-life insurance• Legal representation: DUI• A week vacation in Kenya

o Do you have reference prices for any of these?

• Vending machine Coke• NKU sweatshirt• ¼ Pounder with cheese• A gallon of gas• XM Radio

How do you know what these things SHOULD cost, if you’ve never purchased them before?? What drives their price?

Pricing. Is. Tough. Can. Make. Or. Break. You. Pricing. Is. Tough. Can. Make. Or. Break. You. 10

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End Module 1

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Chapter 11Module 2

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Price Planning is a Careful Process!

DevelopObjectives

EstimateDemand

DetermineCosts

Evaluatethe

Environment

Choose aStrategy

ChooseTactics

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Sales or market share Sales or market share objectivesobjectivesProfit objectives Profit objectives Competitive effect objectives Competitive effect objectives Customer satisfaction Customer satisfaction objectivesobjectivesImage enhancement Image enhancement objectivesobjectives

DevelopObjectives

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EstimateDemand

Demand = CustomersCustomers’’ desire for a productdesire for a productoKey concept is elasticityelasticity

Law of demand: oFor most products, as price goes up,

quantity demanded goes downoFor prestige products, a price increase

may result in more demand (Veblen effect)

ConsumersConsumers’’ response to prices changes. response to prices changes.

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Other things affect demand too

- Competitive Entry- Trends- Stages in PLC- Change in norms/values/CB- Substitute & complimentary products

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But let’s go back to Price.

The percentagepercentage change in sales that results from a percentagepercentage change in price• When changes in price have large effects on the amount

demanded, demand is elasticelastic• When changes in price have little or no effect on the amount

demanded, demand is inelasticinelastic

Price Elasticity of Demand:Price Elasticity of Demand:

Price in Change %

Demanded Quantity in Change %

ItIt’’s all about how s all about how sensitivesensitive demand is to price demand is to price

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How To Do This:How To Do This:Qnew – Qold

Qold

Pnew – Pold

Pold

Very Very sensitivesensitive demand demand

Elasticity coefficient (e)Elasticity coefficient (e) 18

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Very Very insensitiveinsensitive demand demand

Qnew – Qold

Qold

Pnew – Pold

Pold

If e < If e < 1.01.0

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Pizza (generally - but not PJ in our example)

Gasoline

$10

$9

$4

$2

$0.50

$6

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End Module 2

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Chapter 11Module 3

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DetermineCosts

o VariableVariable• The costs of production that are tied to and varyvary

depending upon the number of units produced

o FixedFixed• The costs of production that do not changedo not change with

the number of units produced

o Total:Total: • Fixed + variableFixed + variable costs for a set number of units

produced

Average Cost Average Cost = TotalTotal CostCost/ # units produced

We need to know so that we don’t price under our costs and lose money!!

What’s our BEP?

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Break Even tells us the sales volume we need to achieve in order to make a profit. This is largely dependent on price since it drives our contribution margin.TR = PxQTC = FC + VCProfit = TR - TC

TR = TC

Break Even = TFC _________contr. per unit to FC (Price-AVC)

Unit selling Price = $2.AVC = $1

Contr. Per unit to fixed costs = ???

If TFC = $2,000, how many units do we need to sell @ $2

each to break even?

What about at $3 each?

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But Pricing is not just a function of end user purchase price and manufacturer costs!

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Evaluatethe

Environment

o In general in the economyo In the geography where we operateo Regulations or new legislation?o Are the new consumer trends?

(saving, luxury shopping)o Competitor Prices?

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End Module 3

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Chapter 11Module 4

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Choose aStrategy

Pricing StrategiesPricing Strategieso Cost-based - Cost-based - ““markupmarkup”” actual costs by x% actual costs by x%o Demand-basedDemand-based

• Target - work backwards to see if products can Target - work backwards to see if products can be produced for what people are willing to pay.be produced for what people are willing to pay.

• Yield Management - different prices for Yield Management - different prices for different customers.different customers.

o Competition-basedCompetition-based• Price Leadership - set the market pricePrice Leadership - set the market price

o (Perceived) customer needs (Perceived) customer needs o Yield ManagementYield Managemento New productNew product

• Skimming - high priceSkimming - high price• Penetration - to encourage purchasePenetration - to encourage purchase• Trial Trial

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ChooseTactics

o Pricing for multiple products• Price bundlingPrice bundling: selling two or more goods or

services as a single package for one price• Captive pricingCaptive pricing: pricing two products that

work only when used together

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The Psychology of Pricing

Marketers must understand that price is an important cue for customers.

Consumers • have internal reference prices• experience assimilation and contrast effects• are likely to make price-quality inferences

Marketers use consumer psychology to set pricing strategies:• Odd-even pricing• Price Lining• Prestige Pricing

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End Chapter 11