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Setting the Price
Price is not just a number on a tag of anitem Rent Tuition fees
Medical fees Airline tickets Salary/ Income/ commission Taxes
Prices are sometimes set throughnegotiation between the sellers andbuyers
Reversal of trend Auction
Non-uniform (Nok Air)
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Setting the Price (cont)
Price setting is done in several ways indifferent companies
By the boss
By departments (accounting, production,marketing)
In most cases, a firm must set a price forthe first time when it develops a new
product Introduction into a new or established markets As a key positioning strategy
Defined the expected segment of competitive
market
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Automobile Segment
Segment Examples
Ultimate Rolls-Royce
Gold Standard/ Luxury Mercedes-Benz
Power/ Energy BMW
Safety Volvo
Economy and Fun Honda, FordFamily Toyota
Cosmetics Segment
Segment Examples
Ultimate Channal, DiorCare and Well-being Clinique
Beauty and Fun Stella
Young/ Mass Ponds, Olay
Medical/ Healing Eucerine
Fun/ Mass Mistine
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Price-Quality Strategies
1. Premium
Strategy
2. High-Value
Strategy
5. Medium-ValueStrategy
3. Super-Value
Strategy
4. OverchargingStrategy
7. Rip-OffStrategy
8. False EconomyStrategy
6. Good-ValueStrategy
9. EconomyStrategy
ProductQuality
PriceHigh Medium Low
High
Medium
Low
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Price and Value
Opportunities (orrisk?)
Price = Value
Unharvested Value
Low Medium High
Perceived Value
High
PricePaid
Medium
Low
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SettingthePrice (cont)
Thecompany must setitspriceinrelationtothevalue delivered andperceived bythecustomers
Ifthepriceis higher thanthevalueperceivedopportunity ofprofits orrisksinthe future?
Ifthepriceis lower thanthevalueperceivedmiss opportunityto make moreprofits
To setthe appropriateprice, firm willconsidervarious factorsinpricingpolicy
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SettingthePrice (cont)
1. SelectPricing Objective
2. Determine Demand
3. Estimate Costs
4. Analyze Competitors
5. SelectPricing Methodand FinalPrice
SelectPricing Objectives Decides whereit wantsto
positioninthemarket
Fivemajorpricingobjectives
1) Survival
2) Maximumcurrentprofit
3) MarketPenetration
4) Market skimming
5) Product-qualityleadership
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Pricing Objectives
1. Survival
Facedovercapacity and
intensecompetition
Kee pprices overcosts (variableand fixed)
Sho rt-runobjective
2. Maximize CurrentProfits
Estimatingdemand andcoststo determinethebestpricesthatgivethemostprofits
Assumptions onthose estimations
To e mphasizecurrentperformancemayrisk long-termobjectives
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Pricing Objectives (cont)
3. MarketPenetration
Focus on high salevolumetoresultinlow unitcosts
Long-runprofits
Lowestprice
Assumption onprice sensitivemarket
4. Market Skimming Cha rged highprices for a
selectedgroup of buyers
Assumptions
Sufficientnumber ofbuyers with highdemand
Smallvolume ofproductionispossible(cost factor)
Limitedcompetition
Highpricecommunicates high-qualityimage
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Pricing Objectives (cont)
5. Product-Quality Leader
Focused onrealproduct quality
Cha rged highprices forits worth
Assumptions
Communication ofquality featurestobuyers
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SettingthePrice (cont)
Determine Demand Eachprice willleadto a
differentlevel of demandand have different
impact on acompanysmarketing objectives
Demand Curve showstherelationships betweenpricelevel and demand
Inverserelation
Slopes downward
Slopes upward(prestigegoods)
1. SelectPricing Objective
2. Determine Demand
3. Estimate Costs
4. Analyze Competitors
5. SelectPricing Methodand FinalPrice
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Demand Curve
Quantity (Q)
Price
(P)
100 105
$15
$10
Quantity (Q)
Price
(P)
50 150
$15
$10
(a) Inelastic Demand (b) Elastic Demand
Price Elasticity = % changein Q
% changeinP
Price Elasticity = % changein Q
% changeinP
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Price Sensitivity
The demandcurve showstheprobablepurchasing quantity at alternativeprices
Price-sensitive buyers aremore
influenced bypricechanges A small priceincreaseleadsto a biggerdecreasein quantity demanded elasticdemand
A small priceincreaseleadsto a smallerdecreasein quantity demanded inelasticdemand
Whichtype ofcustomers do firmsprefer?
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Price Sensitivity (cont)
The h igherthe elasticity, thegreaterthevolumegrowth with 1% pricereduction
Demandislikelyto beless elastic: The re are few substitutes/competitors
Buyers donotreadilynoticepriceincreases Buyers are slowtochangetheir buying habits
Buyersthink that higherprices are justified
Whe n demandis elastic, producers willtendto
lowerthepricetoraise salesvolume
higherrevenue
How aboutinelastic demand?
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Price Sensitivity (cont)
Considering discountcoupons;
Who arethecompaniestargeting? Purposes forthecompanies of buyers using and
not-usingthecoupons
Why not have discounts for all buyers?
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SettingthePrice (cont)
Estimate Costs A companyscoststake 2forms
Fixed Donotvary with
production Egrent, interest, salary
Variable
Vary directly withproduction or salesrevenue
Egrawmaterials,packaging
Total Costs = Fixed Costs +Variable Costs
Average Costs = Costper
unit ofproduction
1. SelectPricing Objective
2. Determine Demand
3. Estimate Costs
4. Analyze Competitors
5. SelectPricing Methodand FinalPrice
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Costs
Economies of Scale Spreadingthe fixedcost asproduction
volumeincreases
Averagecost (unitcosts) falls TotalCosts = FixedCost + VariableCosts
AverageCosts = FixedCost + VariableCosts
Unit Unit
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COST ANALYSIS
Rent ($) Material/ Unit ($) Unit Total Cost ($) Average Cost ($)
10,000 10 0 10,000 #DIV/0!
10,000 10 100 11,000 110.0
10,000 10 200 12,000 60.0
10,000 10 300 13,000 43.3
10,000 10 400 14,000 35.0
10,000 10 500 15,000 30.0
10,000 10 600 16,000 26.7
10,000 10 700 17,000 24.3
10,000 10 800 18,000 22.5
10,000 10 900 19,000 21.110,000 10 1000 20,000 20.0
10,000 10 1100 21,000 19.1
10,000 10 1200 22,000 18.3
10,000 10 1300 23,000 17.7
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Total ost ($)
0
5,000
10,000
15,000
20,000
25,000
Unit 0 100 200 300 400 500 600 700 800 900 1000 1100 1200
Total ost ($)
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Aver age Cost ($)
0.0
20.0
40.0
60.0
80.0
100.0
120.0
Unit 0 100 200 300 400 500 600 700 800 900 1000 1100 1200
Average Cost ($)
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AnalyzeCompetitors
Gives an overview ofthemarket
Takesintoconsiderationcosts, prices, features andpossiblereactions fromcompetitors
Possiblepositioning:price higher, lower orthesame ascompetitors
1. SelectPricing Objective
2. Determine Demand
3. EstimateCosts
4. AnalyzeCompetitors
5. SelectPricing Methodand FinalPrice
SettingthePrice (cont)
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SelectPricing Methodand FinalPrice
1) MarkupPricing
2) Target-ReturnPricing3) Perceived Value-Pricing
4) ValuePricing
5) Going-RatePricing
6) Auction-TypePricing English
Dutch
Sealed-Bid
1. SelectPricing Objective
2. Determine Demand
3. EstimateCosts
4. AnalyzeCompetitors
5. SelectPricing Methodand FinalPrice
SettingthePrice (cont)
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1. MarkupPrice Setprice based oncosts and expectedprofit
Example
When unitcost = $60 andthecompany expects20% return, MarkupPrice = $60 / (1-0.2) = $75
(note:notthe same as $60 x 1.2 = $72)
Pricing Methods
MarkupPrice = UnitCost
( 1 Desired Return)
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1. MarkupPrice (cont) Easyto use
Logicalto ensurethat allcosts arecovered
Prices withinthe sameindustry willtendto
become similar (if havethe samecosts) lesspricecompetition
Justifiedtothe buyers (andthe sellers)
Doesthe use of standardmarkups always
makelogical sense? Ignore demand, perceivedvalue and
competition
Assumesthatthemarkupprices bringsinexpectedlevel of sales
Pricing Methods (cont)
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2. Target-ReturnPricing Price yieldstargetreturn oninvestment (ROI)
Usually used for firms withlarge fixedcapital ofinvestment eg automobile, utilities
Example: A toastermanufacturer hasinvested $1millioninthe business and wantsto earn 20% ROI.Expecting 50,000 units sales, targetprice for each
toasteris;= unitcost + ROI x InvestmentCapitalUnit Sale
= $16 + 20% x $1million = $20
50,000
Pricing Methods (cont)
Assumptions?
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2. Target-ReturnPricing (cont) To ensurethatpricecoverscosts atcertainlevel,
Breakeven Analysiscan be used
Withtotal fixedcosts of $300,000, sellingprice at$20 andvariablecosts at $10, thevolumerequiredto breakevenis = $300,000 = 30,000 units
($20 - $10)
What happento breakevenvolumeif fixedcostsincrease?
Ifprice decreases?
Pricing Methods (cont)
Breakeven Volume = FixedCost
(Price VariableCosts)
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3. Perceived-ValuePricing Base onthepromisedvalue deliveredto
customers
Perceivedvalueismade up of several elements
Image, warranty, performance, reputation,buyingconvenience
Buyersplace different emphasis on differentvalue elements
Price buyers:must keeppriceslow; offerthebasics
Value buyers: keepinnovatingnewproductsand aggressively affirmtheirvalue
Loyal buyers: investinrelationship building and
customerintimacy
Pricing Methods (cont)
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3. Perceived-ValuePricing (cont) Doesnot base onmanufacturingcoststo set
price
Add orreduceprice accordingtothevalueelements offered
Pricing Methods (cont)
Sony TVPrice Value
$90 Similartocompetitor (baseprice)
$7 Sonys TV durability
$6 Sonys TVreliability
$5 Sonys superior service
$2 Sonys warranty onparts
-$1 Discount
$100 FinalPrice
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4. ValuePricing The aimis keepcostslowtochargelowprices
Different from offering discount /promotionalprices
Everyday LowPricing
Long-term strategy
Involvesre-engineering operations (internal andexternal) toresultsin efficiency lowcosts
5. Going-RatePricing Bases oncompetitors Followtheleader
EgPetrol
Pricing Methods (cont)
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6. Auction-TypePricing Popular ontheinternet and electronicmarketplaces
Common for disposing excessinventories or usedgoods
Pricing Methods (cont)
1. English Auction (Ascending)- Bidderraiseprices untilthe highest priceisreached
2. Dutch Auction (Descending)- One seller, many buyers
Auctioneer announces a highprice and slowly decreasesthepricetilla bidder accepts
- One buyer, many sellers The buyer announces something he wants and sellerscompeteto
offerthelowestprice
3. Sea led-Bid Auction
- Seller submit aclosed offerto bid
Auction Type
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AdaptingthePrice
Companies usually donot set a singleprice Set apricing structurethat reflects
variationsin: Geographical demand andcosts
Market segmentrequirements Purchasetiming
Orderlevels
Delivery frequency
Servicecontracts With discounts, allowances and
promotional supports, companiesrarelyrealizethe samelevel ofprofit from each
unit ofproduct
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AdaptingthePrice (cont)
Product-Mix Pricing Price-settinglogicmust bemodified whenthe
productispart of aproductline
Firm will searchto setpricesthatmaximizeprofits ofthetotalproductmix
Wecan distinguish6 situationsinvolvingproduct-mix pricing
Product-linepricing, Optional-featurepricing, captive-productpricing, Tow-partpricing, By-productpricing andProduct-bundlingpricing
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Product-Mix Pricing (cont)
5. By-ProductPricing Some by-products have
valuetocertainconsumergroups andshould bepriced ontheir
value Income earned onthe by-
products allowmanufacturerstochargelowerprices onthemain
products Eg Meat andmeatparts, Wood and sawdust, Petroleum andchemicalproducts
6. Product-BundlingPricing
Pure Bundling: Productsare offeredin bundles only
Whole-daypreschoolnursery
Mixed Bundling: Sellersoffergoodsindividually aswell asin bundles
Price ofgoodsinpacksarelowerthatif boughtseparately
Eg Hotelpackages
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Initiating and RespondingtoPriceChanges
InitiatingPriceCutsReasons
Excessplantcapacity
Needtogetmore sales and business
To dominatemarketthroughlowercosts
ConsequencesLow-Quality Trap:Consumersmight
assumethatthe qualityislow
Fragile-Market-Share: Lowpricemay buymarket share butnotloyalty
Price War: Others will follow and firmsthat havethe deeperpockets survive
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Initiating and RespondingtoPriceChanges (cont)
Informationneeded for apricechange Customers ability & willingness
to buy; customerlifestyle;benefits sought; characteristics oftheproduct e.g.
Whenthe kopitiams, localcoffeeshopsin Singaporetriedtoraisetheprice of acup ofcoffee by10centsin March1994, thegrass-
rootreaction was stormyWhen StarbucksCoffee and
Spinellisraisedtheirpricesinthebeginning of1998 by a hefty 20%,nobodyraised an eyelit
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Initiating and RespondingtoPriceChanges (cont)
Three strategic alternatives:
Maintainthepriceif you aretheleader
In1999, Shellin Singaporemaintaineditspricewhen otherpetrolcompanies engagedin aprice
war untiltowardsthe end ofthe engagement Reducetheprice
SIA regularlyreduceits airfarein anticipation ofthe developingmarket situations
Increasetheprice
Duringinflation, orif demandis expectedtoincrease orif you wishto harvest
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Initiating and RespondingtoPriceChanges (cont)
InitiatingPrice Increases Reasons
Toraiseprofits (assumingthegain fromhigherprices exceedsthe fallinvolume ofsales units)
Tocoverrisingcosts
Tocontrol over-demand whenthecompanycannot supply enough
Consequences
Delayed quotationpricing:company doesnot setthe finalprice early
Unbundling:Companymaintainsthepricebutremove somecomponents or services
Reduction of discounts
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Initiating and RespondingtoPriceChanges (cont)
InitiatingPrice Increases (cont) Companiescanrespondtotherisingcosts or
demand withoutraisingprices
Shrink product amount
Substitute withless expensivematerialparts oringredients
Reduce orremovecertain services orproduct features
Useless expensivepackagingSell fewermodels/productlines orinlarger
bulks
Createnew economy brands
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Initiating and RespondingtoPriceChanges (cont)
PriceChanges
Customer Reactions
Questionthemotivation behindthepricechanges
Products areaboutto bereplaced?
Theitems arefaulty ornotselling well?
The quality hasbeenreduced?
Competitor Reactions
Treats eachpricechange as a freshchallenge andreact
accordinglyto self-interest atthetime
Searchcurrentfinancial situation,recent sales,
customerloyalty,market share
Differentcompetitorshave differentinterpretations on a
pricechange
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RespondingtoCompetitors PriceChanges
Inmarketscharacterized by homogeneousproducts, firms will keepprices stable and anypricechange will be brought back tonormallevel withtime
Collectivepricechange will followifitimprovetheindustry as a whole
Inmarkets wheregoods are differentiated,players will havetoconsidermany factorstodecide onthemoves
Whypricecut?, Willit betemporary?, Whathappenstomarket share?, How are othercompaniesgoingtorespond?
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RespondingtoCompetitors PriceChanges (cont)
Marketleaders frequently faceaggressivepricecutting by smaller firmstryingto buildmarket share
Theycanrespondin several ways
Maintainprice: Remaincalm, hoping forstablemarket situation (profits andmarketshare)
Maintainprice and addvalue
Reduceprice: expect high sales and fallingcosts (economies of scale)
Increaseprice andimprove quality
Launch alow-price fighterline
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RespondingtoCompetitors PriceChanges (cont)
The bestresponsevaries withthesituation
Products LifeCycle
Importancetocompanyportfolio Competitors intention
Ownresources
Markets sensitivitytoprice and
quality
Behavior ofcosts with salesvolume
Alternative options
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A Price ReactionProgram
Hascompetitorcut hisprice?
Hold ourprice andcontinueto watchcompetitorsprice
Isthepricelikelyto hurt our sales
significantly?
Isitlikelyto bepermanentprice
cut?
Howmuchisthepricecut?
Lessthan 2%Introduce
discountcoupon
By 2-4% Dropprice by half of
thepricecut
Morethan 4%Droppriceto
matchcompetitor
No
Yes
YesNo No
Yes