Product & Pricing Issues

May 5, 2004

Agenda

• Product Positioning

• Meanings of Price

• Demand & Pricing Strategies

• Elasticity

• Bundling

What to Say?• Positioning – Main thought to associate with the company

– Sun Microsystems – “The Dot in Dot.Com”

– Microsoft – “Where Do You Want to Go Today”(Gates) to “Empower People Through Great Software Anyplace, Any Time, and on Any Device” (Balmer)

– Dell – “Be Direct”

– Gateway – “You’ve Got A Friend in the Business” to “Connect with Us”

Price Definitions

• Consumer – what must be sacrificed in order to possess or use a product.– (money, time, effort)

• Producer – what is received in return for the transfer of possession or usage rights to the consumer– (money, products, goodwill)

Prices Do Not Always Reflect Direct Costs

Sales # Albums Selling

> 1 million 60

500,000 – 999,999 52

250,000 – 499,999 95

100,000 – 249,999 208

< 100,000 6,040

Organizational Objectives & Pricing Strategies

• Status Quo – Cost-oriented

• Sales Revenue Maximization – Demand-oriented

• Market Share Maximization – Competition-oriented

• Profit Maximization – Demand & Cost-oriented

Cost-Oriented Pricing

Manufacturer(20%)

Wholesaler(25%)

Retailer(50%)

Cost $20

Markup $4

Selling Price

$24

Break Even Analysis

1. TR = TC + Pr where TR = Total Revenue

TC = Total Cost = Fixed + Variable= FC + VC * Q

Pr = Profit Margin Desired

2. P * Q = (FC + VC * Q) + Pr

3. Q = (FC + Pr) / (P - VC)

Break Even Analysis (example)

• Let FC = $1000

VC = $2 / unit

Pr = $600

Price - $10 Q = ($1000 + $600) / ($10 - $2) = 200 units

Price - $8 Q = ($1000 + $600) / ($ 8 - $2) = 266 units

Q P TR TC Profit MR MC

0 $150 $200

1 $140 $296

2 $130 $316

3 $117 $331

4 $105 $344

5 $92 $355

6 $79 $368

7 $66 $383

8 $53 $423

9 $42 $507

10 $31 $710

Q P TR TC Profit MR MC

0 $150 0 $200 -$200

1 $140 $140 $296 -$156 $140 $96

2 $130 $260 $316 -$ 56 $120 $20

3 $117 $351 $331 $ 20 $ 91 $15

4 $105 $420 $344 $ 76 $ 69 $13

5 $92 $460 $355 $105 $ 40 $11

6 $79 $474 $368 $106 $ 14 $13

7 $66 $462 $383 $ 79 -$ 12 $15

8 $53 $424 $423 $ 1 -$ 38 $40

9 $42 $378 $507 -$129 -$ 46 $84

10 $31 $310 $710 -$400 -$ 68 $203

Economics of Pricing

-$100

-$50

$0

$50

$100

$150

$200

$250

$300

$350

1 2 3 4 5 6 7 8 9 10 11

MR

Demand

MC

Avg Cost

Pricing & Strategy

1. Volume - Maximize unit sales

• (subject to not losing money)

2. Market Share – Maximize market share

3. Maximize Profits

4. Maximize Sales Revenue

Price Elasticity

• Percent change in quantity sold for a given percent change in price.

E = (Q / Q) / ( P / P)

Price Elasticity

• Quantity (3-2)/2 = 50%

• Price ($117-$130)/$130 = -10%

• Elasticity = 50% / -10% = -5

Q P TR %Q % P Elast

0 $150 $0

1 $140 $140

2 $130 $260 100% 7.1% -14.1

3 $117 $351 50% 10.0% -5.0

4 $105 $420 33% 10.2% -3.2

5 $92 $460 25% 12.4% -2.0

6 $79 $474 20% 14.1% -1.4

7 $66 $462 16.7% 16.4% -.98

8 $53 $424 14.3% 19.7% -.72

9 $42 $378 12.5% 20.8% -.60

10 $31 $310 11.1% 26.2% -.42

Price Bundling

• Bundling – when several related items are sold together for a packaged price, usually lower than each item separately.

• Amazon – always offers the album selected with a similar one for a combined price.

Advantages of Bundling (Variable Cost is $3 per service)

Customer Voice Mail Hot Line Both

A $5.00 $3.50 $8.50

B $5.50 $4.00 $9.50

C $4.00 $5.00 $9.00

D $3.50 $4.50 $8.00

Current ($5.50 for Voice & $5 for Hot Line)

Customer Voice Mail Hot Line Both

A $5.00 $3.50 $8.50

B $5.50 $4.00 $9.50

C $4.00 $5.00 $9.00

D $3.50 $4.50 $8.00

Optimal PricesPrice-Voice Mail

Price- Hot Line

Price-Both

Services Purchased

Sales Revenue

Variable Costs

Gross Profit

Current

$5.50 $5.00 2 $10.50 $6 $4.50

Sell All Services to Everyone(Variable Cost is $3 per service)

Customer Voice Mail Hot Line Both

A $5.00 $3.50 $8.50

B $5.50 $4.00 $9.50

C $4.00 $5.00 $9.00

D $3.50 $4.50 $8.00

Optimal PricesPrice-Voice Mail

Price- Hot Line

Price-Both

Services Purchased

Sales Revenue

Variable Costs

Gross Profit

Current

$5.50 $5.00 2 $10.50 $6 $4.50

Max Units

$3.50 $3.50 8 $28 $24 $4

Sell to Everyone(Variable Cost is $3 per service)

Customer Voice Mail Hot Line Both

A $5.00 $3.50 $8.50

B $5.50 $4.00 $9.50

C $4.00 $5.00 $9.00

D $3.50 $4.50 $8.00

Optimal PricesPrice-Voice Mail

Price- Hot Line

Price-Both

Services Purchased

Sales Revenue

Variable Costs

Gross Profit

Current

$5.50 $5.00 2 $10.50 $6 $4.50

Max Units

$3.50 $3.50 8 $28 $24 $4

Max Cust

$5.00 $4.50 4 $20 $12 $8

Pure Bundling(Variable Cost is $3 per service)

Customer Voice Mail Hot Line Both

A $5.00 $3.50 $8.50

B $5.50 $4.00 $9.50

C $4.00 $5.00 $9.00

D $3.50 $4.50 $8.00

Optimal PricesPrice-Voice Mail

Price- Hot Line

Price-Both

Serv. Purch.

Sales Rev.

Variable Costs

Gross Profit

Current

$5.50 $5.00 2 $10.50 $6 $4.50

Max Units

$3.50 $3.50 8 $28 $24 $4

Max Cust

$5.00 $4.50 4 $20 $12 $8

Pure Bund.

$8 8 $32 $24 $8

Mixed Bundling(Variable Cost is $3 per service)

Customer Voice Mail Hot Line Both

A $5.00 $3.50 $8.50

B $5.50 $4.00 $9.50

C $4.00 $5.00 $9.00

D $3.50 $4.50 $8.00

Mixed Bundling($5 for Voice, $4.50 for Hot Line & $9 for bundle)

Customer Voice Mail Hot Line Both

A $5.00 $3.50 $8.50

B $5.50 $4.00 $9.50

C $4.00 $5.00 $9.00

D $3.50 $4.50 $8.00

Optimal PricesPrice-Voice Mail

Price- Hot Line

Price-Both

Serv. Purch.

Sales Rev.

Variable Costs

Gross Profit

Current $5.50 $5.00 2 $10.50 $6 $4.50

Max Units

$3.50 $3.50 8 $28 $24 $4

Max Cust

$5.00 $4.50 4 $20 $12 $8

Pure Bund.

$8 8 $32 $24 $8

Mixed $5.00 $4.50 $9.00 6 $27.50 $18 $9.50