Session 3_Easy_Pricing

• VO Management I - Marketing (MA)
• Week 3 - Pricing
• Christoph Fuchs is the Chair of Marketing, at the university
• Contact: [email protected], http://marketing.univie.ac.at
• Office hours are upon request

Course Framework

• Prerequisites: Marketing Research and Consumer Behaviour
• Marketing Strategy: Segmentation, Targeting, and Positioning (STP)
• Marketing Plan includes Product, Price, Promotion, and Place.

Pricing Question

• A company sells 100,000 units of a product annually for $100 each.
• Variable cost is $60 per unit.
• Fixed overheads are $3 million.
• Two options for the next year: Increase unit sales by 1% by keeping the current price, or increase price by 1% with the same sales volume.

The Leverage of Price

• Price is a strong determinant of operating profits
• Example Case Base:
  • Price: $100
  • Cost (Variable): $60
  • Volume: 1 million
  • Costs (Fixed): $30 million
  • In this scenario, operating profits are $10 million
• Improving Fixed Costs lowers operations costs by saving of $3M
  • Old Fixed Cost: $30M vs New Fixed Cost $27M gives 30% improvement in operating profit to $13M
• Improving Volume increases sales to 1.1M units
  • Old Volume: 1M units vs New Volume 1.1M units gives 40% improvement in operating profit to $14M
• Improving Variable Costs reduces costs by $6 per unit
  • Old Variable Cost $60 vs New Variable Cost $54 gives a 60% improvement in operating profit to $16M
• Improving Price raises price by $10 per unit
  • Old Price $100 vs New Price $110 gives 100% improvement in operating profit to $20M

Price Volume Trade Off

• Evaluates reducing price and getting enough additional volume to increase profits, using incremental break-even analysis.
• Based on average income statements of 1,200 largest publicly held companies in 2002.
• A 5.0% price decrease requires a 17.5% volume increase to break even.

Overview of Pricing

• Price is the sole element of the marketing mix that generates revenue.
• It significantly affects profitability.
• Key requirements of pricing policy: complementing strategic goals and alignment with perceived customer value.
• Pricing is subject to psychological biases.

Price & Demand

• Key question: what is the relationship between price and demand
• Elasticity is a key element of this relationship
• Graph A outlines an "Inelastic demand"
  • Quantity decreases marginally when prices increase
• Graph B outlines an "Elastic demand"
  • Quantity decreases more significantly than with inelastic demand, relative to the price increase

Price Elasticities

• Price elasticities are important and have to be taken into account for pricing strategies.
• Price elasticity of demand illustrates the response of demand to a change in price.
• Inelastic demand occurs when demand changes negligibly with a small price adjustment.
• Elastic demand happens when demand significantly changes with a small price adjustment.
• Price elasticity of demand is calculated as: % change in quantity demand / % change in price

Price elasticity in the product life cycle

• Product price elasticity is impacted during the product's overall lifecycle, especially when competitors enter the market

Value Assessment

• Value is assessed to determine demand curves

Demand Curves

• Demand curves based on consumers' willingness to pay, as seen from a graph labeled "Demand curves based on consumers' WTP"

Pricing Factors

• Price setting considerations
  • Product costs set the price floor, below which no profits are made
  • Competition and other external factors
  • Consumer perceptions of value set the price ceiling, above there is no demand

Cost-Based Pricing

• Cost plus pricing process
  • Material cost + Manufacturing cost are added
  • Production cost + Administration and distribution cost
  • These make the "Cost Based Price" + Profit margin
  • Net sales price is then added to VAT(value added tax)
  • = Gross sales price

Cost Based Pricing

• Break Even Pricing calculates a point where revenue is equal to costs (there is zero profit)
• Target Return Pricing finds a price the firm to break even, or make the profit it's seeking

Competition Based Pricing

• Sets prices based on competitors' strategies, costs, and market offerings.
• Consumers base their product value judgments on competitors' prices for similar items.
• It raises the question of the problems with cost-based and competitor-based pricing, if any?

Customer-Value Based Pricing

• There is the question of designing something good, versus something designed to deliver higher perceived value to a target price based on customer needs

Pricing Strategies

• Include Penetration Pricing, and Price Skimming

Penetration vs. Skimming

• Penetration pricing involves a low initial price to quickly gain market share, while skimming starts with a high price that is lowered over time.

Skimming vs, Positioning

• Penetration Pricing Strategy:
  • Has a low margin and high volume
  • Works well with economies of scale in production costs
  • This captures a large share of the market (first mover advantage) but is easily copied unless there is a prod. adv.
  • It dissuades others from entering the market by keeping prices low, but competition is still very possible
  • Dangerous if there is a strong negative price-quality association
  • Limits flexibility because consumers react more strongly to price increases than price deceases
• Skimming (Prestige Pricing)
  • Uses high margins at expense of volume
  • Works well early in product life cycle, because "early adopters" are less sensitive to price
  • Only works if there is little risk of competition
  • Works if there is a strong price-quality association
  • More flexibility because the price can be reduced if necessary

Buyer Types

• Penetration Pricing:
  • For markets sensitive to price, where low prices stimulate market growth.
  • When production and distribution costs decrease with accumulated production experience.
  • Low prices discourage actual and potential competition.
• Skimming Pricing:
  • Suitable when a sufficient number of buyers have high demand.
  • When unit costs of producing a small volume are not so high, allowing cancellation of charging what traffic will bear.
  • High initial price communicates brand's superior product image.

Loss Leader

• The concept of pricing a product at a loss to attract customers, who then purchase other, more profitable items

Price Differentiation (Price Discrimination)

• Forms of price discrimination
  • Quantitative (small vs. large quantities)
  • Qualitative (depending on willingness to pay - WTP - of segments)
  • Temporal (morning vs. evening)
  • Location-based (urban vs. rural)
• Dynamic/demand/real-time pricing
  • Different price at different time, depending on demand, competition, capacity, etc.
• Personalized pricing
  • Different price for different buyers, estimates of individual's value price, whether they can select or not

Complementary Pricing

• Pricing complementary products to maximize overall profitability
• What is someone willing to pay if a product is required to utilize another existing product
• As prices increase as consumer is "locked" in to other required or companion products
  • (IE Nespresso Machine)
• The razor and blades business model is an example of complementary pricing.

Dynamic Pricing

• A pricing strategy where companies adjust prices according to market demand; also referred to as surge pricing.
• Model uses automatic algorithms based factors like competitor pricing, supply and demand
• Ex: Uber surge pricing, Wendy's testing of surge pricing
• See case "Dynamic Pricing Keeps Spreading, Despite Protest From Wendy's Customers"

Psychology of Price & STP

• Price effects perception of quality and value
• Consumers infer meaning from price, using that information to guide buying decisions
• Price is a signal
• Wine seems to taste better when it is more expensive

Price Tactics - Communication

• Consumers extract meaning from price
• Consumers make inferences around the valence of an experience
• Price communications should follow evidence-based principles
• Show that prices a great value, against a reference price
• Odd prices tend to work better in most scenarios
  • Compare price being in odd vs even numbers
• Don't be fooled by reference prices.

Odd Numbers

• Reference Prices use tactics such as suggesting higher original price as indicator of value
  • "Original price"
  • "Regularly priced"
  • "Comparison price"
  • "Manufacturer's suggested list price"
• People are persuaded by odd prices
• People perceive odd numbers to be significantly less than a round numbers
• Odd price communicates a "sale!"
• Odd price is harmful to recall, but it works when it reduces the digit on the left
• Round price is better for honest as it shows a higher quality

Price Key Points

• Price is a key element
• It is the only element of the marketing mix that brings in revenue and impacts profitability
• Price cannot be used in a silo though, is its a crucial component in customer overall value
• Price requirements: Complement strategic goals and appeal to perceived consumer value
• Price is subject to psychological biases

Explore the influences on pricing decisions, including dynamic strategies and consumer perception. Understand the role of pricing in the marketing mix and its impact on operating profit. Learn about key considerations for effective price communication and policy.