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Setting the right price

The real issue is value, not price !

Price is determined by what the consumer is willing to pay,

not the cost to manufacture, distribute, and

promotepromote.


The buying situation or context as well as the core dimension of the product determine what a consumer is willing to pay.

For example:

• Consumers are willing to pay much more for a cup of coffee in ‘Barista’ than in an Udipi restaurant

• They are willing to pay more for clothing they buy at ‘Westside’ than for clothing they buy at ‘Globus’ or ‘Reliance Trends’.

• They pay more for items like the latest cell phones than they should…

• They want to purchase expensive perfume for gifts rather than cheap perfume even though the cost of manufacturing is not much different.

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• Price is like a thermometer in that the higher we can push the price, the better jobwe have done with uncovering consumer needs and designing the marketing mix.

• It doesn’t take any marketing skill to sell a product at a low price. Marketers earntheir keep by getting a premium price for products and services.


p y g g p p p

• Reference price is an important concept in pricing strategy. There is an externalreference price—what everyone else is paying for the product—and an internalreference price—what you think you should pay given your past experience andthe buying situation.

• There are four basic pricing approaches—cost plus, value-in-use, penetration, andki i b t lti t l i d d th b fit f th d t thskimming, but ultimately price depends on the core benefit of the product, the

context, and how well you’ve done the rest of your marketing.

• Price is the most abstract of any of the four marketing mix elements. It is a signalof product quality and status. It is inherently subjective and tied to consumerperceptions rather than objective reality.

Price and Perceived Value

The Economic Perspective

ObjectivePrice

Perceptionof Price

PerceivedCosts

PerceivedBenefits

Willingnessto Buy

PerceivedValue

Costs

So, according to the economic perspective, consumers will purchase wheneverPerceived Value > 0

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Objective Value

Perceived Value

MarketingEfforts

Price ofSubstitutes

Consumer’s Incentive to Purchase= [Perceived Value – Price]

Product Price

Rs. 0

Cost of Goods Sold

Firm’s Incentive to Sell= [Price – COGS]



Adding a Behavioral or Psychological Component

This perspective captures “how fair a deal” one is getting.

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Behavioral Updates to Economic Perspective

Consumer Willingnessto Buy

Economic Utilityof the Transaction

Fairness of theTransaction= +

P i d V l A t l P i

1. Relative Incentives

Perceived Value – Actual PriceActual Price

2. Reference PricesActual Price – Reference Price

Perceived Value – Actual Price3. Cost of Goods Sold

Actual Price – COGS

4. Nature of the productdiscretionary vs. necessaryluxury vs. utilitarian


Therefore to price correctly, you must understand the buying situation and the heart of the consumer.

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Effect of Price on Profit

% Improvement in operating profits

10%

2%

12%

Purchase Price

Fixed Costs

Marketing Investments

4%

14%

0% 2% 4% 6% 8% 10% 12% 14% 16%

Sales Quantity

Sales Price

Consider the following six-step procedure for setting a price.Stage 1: Selecting the Pricing Objective.

Consider various types of pricing objectives.

Setting Pricing Policy

Consider various types of pricing objectives.Stage 2: Determining Demand.

Estimate demand curves and the magnitude of consumers’ sensitivities to demand.

Stage 3: Estimating Costs.Estimate types of costs and identify experience curve.

Stage 4: Analyzing Competitors’ Costs, Prices, and Offers.Consider competitors’ values.

Stage 5: Selecting a Pricing Method.Consider various types of pricing methods .

Stage 6: Selecting the Final Price.Consider the impacts of other marketing activities.

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1. Selecting the pricingobjective

2. Determining demand

3. Estimating costs

4. Analyzing competitors’4. Analyzing competitorscosts, prices, and offers

5. Selecting a pricingmethod

6. Selecting final price

Setting Pricing Policy1. Selecting the pricing

objective

• Survival

M i i l• Maximize sales revenue

• Maximize profits

• Maximize growth (unit sales)– market penetration– experience curve

• Market skimming• Market skimmingInelastic DemandUnique and patented productUncertain production and marketing costsCapacity constraints in productionHigh perceived value

• Product Quality Leadership

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Maximize Sales RevenueAssume:

P250

Q = 1000 – 4PSales = P x QSales = P(1000-4P)

Sales = 1000P – 4P2

ds = 1000 – 8P

Selecting the Pricing Objectives

Q10000

dp= 1000 – 8P

0 = 1000 – 8P8P = 1000

P = 125

60000

80000

-80000

-60000

-40000

-20000

0

20000

40000

60000

25 50 75 100 125 150 175 200 225 250 275 300

Maximize ProfitP

250 Q = 1000 – 4P Profit = P(1000 – 4P) – [50 (1000-4P) + 6000]

Profit = Sales - CostProfit = (P x Q) – [(VC x Q) + FC]

Profit = 1000P – 4P2 – 50,000 + 200P - 6000


Q10000

CostC 6000 + 50Q

0 = 1200 – 8P

8P = 1200P = 150

dprofitdp = 1200 – 8P

80000

Q

6000

C = 6000 + 50Q

-80000

-60000

-40000

-20000

0

20000

40000

60000

25 50 75 100 125 150 175 200 225 250 275 300

RevenueCostProfit

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Price Skimming and Penetration

PricePenetration Pricing

Price

Skimming Pricing

Sell at highprice beforereducing to


Wholemarket price

reducing tonext price leveland repeatInitial

Price

SecondPrice

Final

QuantityQuantity

Price

Experience Curve• Each time the cumulative production doubles, the cost in realamount will decline by a fixed percentage.

• This pattern of cost decline is a result of:


s patte o cost dec e s a esu t o :– learning to perform tasks more efficiently– technological improvements

– product redesigns

– economies of scale

• Example: 85% experience curve• Example: 85% experience curve– Each time total accumulated production doubles, cost will be

reduced to 85% of its previous level.

Implication: A firm can gain an advantage by accumulating experiencefaster than competitors.

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Experience CurveFormulaCn = Cs (Qn/Qs)b

Where Cn = Cost now Assume:


nCs = Cost startingQn = Quantity nowQs = Quantity startingb = Experience coefficient

Cn = 85Cs = 100Qn = 4000Qs = 2000

Solving for b:100

120

85 = 100 (4000/2000)b

85 = 100 (2)b

85/100 = 2b

ln 0.85 = b ln 2-0.163 = b (0.693)

-0.235 = b

0

20

40

60

80

0 2000 4000 6000 8000 10000 12000 14000

Cumulative Production

Cos

t

PriceHigh Medium Low

Price - Quality StrategiesSelecting the Pricing Objectives

High

duct

Qua

lity

Med

Premium Value

Medium ValueOvercharging

High Value

SuperValue

Good-Value

Low

Prod

EconomyRip-Off FalseEconomy

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• Each price the company might charge will lead to a different demand and will therefore have a different impact on its marketing objectives.

• The relation between price and demand is captured in the familiar demand schedule.schedule.

• The demand curve shows the number of units the market will buy in a given time period at alternative prices.

• In the normal case, demand and price are inversely related, that is, the higher the price, the lower the demand.

Pure CompetitionPure CompetitionMany Buyers and Sellers WhoHave Little Affect on the Price.

Monopolistic CompetitionMonopolistic CompetitionMany Buyers and Sellers Trading

Over a Range of Prices.

Determining Demand

g

Different Types of Markets

Oligopolistic CompetitionFew Sellers Each Sensitive to Other’s

Pricing/ Marketing Strategies

Pure MonopolySingle Seller

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ice

A. Inelastic Demand -Demand hardly changes witha small change in Price.

P2

Determining Demand

Pri

Quantity Demanded per Period

P1

Q1Q2

B. Elastic Demand -Demand changes greatly with

ll h i P i

Pric

e

Quantity Demanded per Period

P’2

P’1

Q1Q2

a small change in Price.

Factors affecting price sensitivity• unique value• substitute awareness

Determining Demand

substitute awareness• difficult comparison• total expenditure• end benefit• shared cost• sunk investment• product quality• inventory

Methods of estimating demand• lab test• field test (in store)• natural experiment

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objective

2 D t i i d d2. Determining demand

3. Estimating costs

Demand sets the ceiling for the price and Costs set the floor.

Costs Competitors’prices andprices ofsubstitutes

Customers’assessmentof uniqueproductfeatures

Low Price

No possibleprofit atthis price

High Price

No possibledemand atthis price


objective

2. Determining demandg

3. Estimating costs

4. Analyzing competitors’costs, prices, and offers

Costs Competitors’prices andprices ofsubstitutes

Customers’assessmentof uniqueproductfeatures

Low Price

No possibleprofit atthis price

High Price

No possibledemand atthis price

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Price-Reaction Program for Meeting a Competitor’s Price Cut

Has competitorcut his price?

NoNoHold our priceat present level;

continue to watch

Analyzing Competitors’ Costs, Prices & Offers

cut his price? continue to watchcompetitor’s

price

Is the pricelikely to

significantlyhurt our sales?

YesYes

Is it likely to bea permanent

price cut?YesYesHow much hashis price been

cut?YesYes

NoNo NoNo

By more than 4%

Drop price tocompetitor’s

price

By 2-4%

Drop price byhalf of the

competitor’sprice cut

By less than 2%

Include acents-off coupon

for the nextpurchase




3. Estimating costs

4. Analyzing competitors’4. Analyzing competitorscosts, prices, and offers

5. Selecting a pricingmethod

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What kinds of pricing methods can be considered?

Cost-Based Pricing:

Selecting a Pricing Method

– Markup pricing– Break-even or target-return (target-profit) pricing.

Value-Based Pricing:– Perceived-value pricing.– Value pricing

Competition-Based Pricing:– Going-rate pricing– Going-rate pricing.

Dynamic Pricing:– Bid-based or auction-type pricing.

Cost-Based MethodsPrice = Average Costs + Mark Up

Pricing Methods

PricingStrategies

Competitor-Based MethodsPrice = Following Rival Prices

Market-Based MethodsPrice = Following Market ConditionsInteraction Demand & Supply

Mkt. Skimming Price Mkt. Penetration Price

Discount Pricing and Segmented Pricing Strategies

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Mark-up or Cost-plus PricingTo set price based on a desired mark-up (also called Cost-Plus . .Cost + some %) Mark-up = % profit based on cost

Selling Price - CostSelling Price CostCost

Cost = Rs. 25; Desired mark-up = 20% i.e. Rs. 25 x 1.20 = Rs. 30

Cost-Plus Pricing delusion……..At Unit Variable Cost = Rs. 5 and Fixed Cost = Rs. 2,000Demand =100 units ; Total Unit Cost = Rs 25 ; Selling Price = Rs 30Demand =100 units ; Total Unit Cost = Rs. 25 ; Selling Price = Rs.30 Demand =200 units ; Total Unit Cost = Rs. 15; Selling Price = Rs. 18Demand =400 units ; Total Unit Cost = Rs. 10; Selling Price = Rs. 12

Adding a Standard Markup to the Cost of the Product

Mark-up or Cost-plus Pricing

MinimizesPrice

Competition

P i d

Sellers Are MoreCertain About

Costs Than Demand

PerceivedFairness to

Both Buyersand Sellers

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A toy manufacturer invested Rs.10,00,000; wants 20% ROI; Fixed cost = Rs. 300,000; variable cost = Rs.10/unitEstimate = 50,000 unit sales (therefore, fixed cost/unit = Rs. 6).

Target Return Pricing

What is the price?

Target-return price = unit cost + (invested capital x desired return) / unit sales

Target-return price = (10+6)+ (10,00,000 x 20% )/50,000 = Rs. 20

Tries to determine the Price at which a Firm will Break Even or make a Target Profit

Target Return (Profit) Pricing

200400600800

1,0001,200 Total Revenue

Total Cost

Fixed Cost

Target Profit(Rs. 200,000)

Cos

t in

Rs.

(tho

usan

ds)

10 20 30 40 50

Sales Volume in Units (thousands)

C

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Product CustomerCost-Based Pricing Value-Based Pricing

Value-Based Pricing

Cost

Price

Value

Price

Value

Customers

Cost

Product

Perceived Value-Based Pricing

Perceived value the value of the benefits from theproduct/service in consumers’ mind.

It include both product actual value and emotional value gainfrom using the product/service.

The perceived value of a product/service differs fromThe perceived value of a product/service differs fromconsumer to consumer.

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Perceived Value-Based Pricing

Perceived value A

Fixed costs

Variable costs

Perceived value APrice

Profit

Am

ount

Rs.

Perceived Value-based PricingAttributes Sai Sagar BaristaCoffee Flavours 1 7Coffee Aroma 1 7H i i C diti 3 7Hygienic Conditions 3 7Quantity of Coffee 3 6Crockery & Cutlery 2 7Ambient Temperature 2 7Music Played 1 7Television/Video 1 7Seating Arrangement 2 7Time Restrictions? 2 7Attitude of Servers 3 6Average Score 1.91 6.82

If Sai Sagar Coffee is Rs. 12.00 then Perceived Value of Barista Coffeewill be Rs.12 x (6.82/1.91) = Rs. 43

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Setting Prices

Competition-Based Pricing

Going-Rate Company sets Prices based on what

Competitors are charging.

Sealed-BidCompany sets Prices based on what they think Competitors

will charge.

Selecting the Final Price

Types of pricing strategies that are popular

Fi d P i i St t i• Fixed Pricing Strategies:– Setting one price for all buyers.– Examples: Price leadership strategy and promotional strategy, etc.

• Segmented Pricing Strategies:– Charging different prices for different customers.– Examples: Segmented pricing such as geographic and value pricing, etc.

• Dynamic or Negotiated Pricing Strategies:– Charging different prices for individual customers.– Examples: online auctions, name your own price, etc.

• Pricing Strategies for Information Goods:– Considering the cost structure of information goods.

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Pricing Strategies for Information Goods

• First-Degree Price Discrimination– The firm sells different units of the product for different prices and these

prices may differ from consumer to consumer. – It is known as perfect price discrimination.

• Second-Degree Price Discrimination– The firm sells different units of a product for different prices, but every

individual who buys the same amount of the product pays the same price. – One example is quantity discount.

• Third-Degree Price Discrimination– The firm sells the product to different people for different prices, but p p p p ,

every unit of product sold to a given individual sells for the same price. – Examples are senior citizen’s discount, student discount.

Product Line PricingProduct Line PricingSetting price steps between product line items

i.e. Rs. 299, Rs. 399

OptionalOptional--Product PricingProduct PricingP i i ti l d t

Examples of Pricing Strategies

Pricing optional or accessory productssold with the main product

i.e. Car OptionsCaptiveCaptive--Product PricingProduct PricingPricing products that must be used

with the main producti.e. Razor Blades, Film, Software, Printer Cartridges

ByBy--Product PricingProduct Pricing

TraditionalPricing

Strategies

Pricing low-value by-products to get rid of themi.e. Cut-pieces from a fabric length

ProductProduct--Bundle PricingBundle PricingPricing bundles of products sold together

i.e. Soaps, Shirts, Dresses

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• Adjusting prices for psychological effect.•Price used as a Quality indicator.i.e. Sony Bravia LCD TV vs Samsung or LG

Psychological Pricingi.e. Sony Bravia LCD TV vs Samsung or LG

• Temporarily reducing prices to increaseshort-run sales.i.e. Loss Leaders, Special-Events

• Adjusting Prices to account for thegeographic location of customers.i.e. FOB-Origin, Uniform-Delivered, Zone Pricing & Freight-Absorption.

Promotional Pricing

Geographical Pricing

• Adjusting prices for International markets.i.e. Price depends on Costs, Consumers,Economic Conditions & Other Factors.

International Pricing


Traditional Pricing Strategies

Discount & AllowanceReducing Prices to Reward SegmentedReducing Prices to Reward

Customer Responses such asPaying Early or Promoting

the Product.

gAdjusting Prices to Allow

for Differences in Customers,Products, or Locations.

Cash Discount

Quantity Discount

Customer

Product Form

Functional Discount

Seasonal Discount

Location

Time

Trade-In Allowance

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VersioningVersioningA form of second-degree price discrimination

i.e. Premium and Economy Pricing

BundlingBundlingMany information goods are sold in large bundles

i.e. Music files in an album, MS Office

FixedFixed--Fee PricingFee PricingGiving customers unlimited usage for a flat fee

i.e. Unlimited Internet usage By MTNL

Other Pricing StrategiesOther Pricing Strategies

PricingStrategies

for Information

GoodsUsing first-degree price discrimination

i.e. Online auctions at eBay

Other Pricing StrategiesOther Pricing StrategiesUsing third-degree price discrimination

i.e. Group pricing for software

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