BA 100 - Pricing and Price Discrimination (Fall 2024) PDF

BA 100 – Introduction to Ross Pricing and Price Discrimination Fall 2024 © 2024 All rights reserved, University of Michigan  Strategy to Determine Price ▪ What objective have firms?...

BA 100 – Introduction to Ross Pricing and Price Discrimination Fall 2024 © 2024 All rights reserved, University of Michigan  Strategy to Determine Price ▪ What objective have firms? ▪ Profit Maximization ▪ Does this mean the firm sets a high price? ▪ Market share ▪ Does this mean the firm sets a low price? ▪ Firm will need to think about the nature of the market ▪ How easy is it to compare prices? ▪ Brand and corporate image ▪ Ethical considerations ▪ ….. © 2024 All rights reserved, University of Michigan  Price Setting - Cost Oriented Pricing Selling Price = Selling Costs + Profit Markup X 100% Markup Percentage = —--------------- Sales Price Markup has to cover all the selling costs and generate enough profit to cover other costs © 2024 All rights reserved, University of Michigan  Price Setting - Cost Oriented Pricing Break-even Point: The number of unit sales at which total revenue equals total costs, resulting in neither profit nor loss. The break-even point in units can be calculated using the formula: Break-Even Point (units) = Fixed Costs Selling Price per unit − Variable Cost per unit © 2024 All rights reserved, University of Michigan  Break-Even Analysis - Example Selling Price per Cup (SP): $5 Fixed Costs (FC) per month: Rent: $3,000 Salaries: $5,000 Utilities: $500 Equipment Depreciation: $500 Variable Costs per Cup (VC): Coffee Beans: $1 Milk and Sugar: $0.50 Cups, Lids, and Sleeves: $0.30 In your teams, calculate the break-even point © 2024 All rights reserved, University of Michigan  Break-Even Analysis - Example ▪ Determine the contribution margin per unit: ▪ Contribution Margin = Selling Price − Variable Cost ▪ Contribution Margin = $5 − $1.80 = $3.20 ▪ Calculate the break-even point in units: ▪ Break-Even Point (units) = $9,000 / $3.20 ▪ Break-Even Point (units) = 2,812.5 ▪ The coffee shop needs to sell approximately 2,813 cups of coffee per month to cover all fixed and variable costs. At this sales level, the shop will break even, meaning it will neither make a profit nor incur a loss. ▪ So, the coffee shop must generate approximately $14,065 in sales revenue to break even. © 2024 All rights reserved, University of Michigan  Fixed and Variable Costs - Not that easy to always distinguish ▪ Mixed Costs: ▪ Some costs have both fixed and variable components. For example, a utility bill might have a fixed base charge plus a variable charge based on usage. Separating these components can be complex. ▪ Step Costs: ▪ Certain costs remain fixed up to a point but will increase in steps once a certain level of activity is reached. For example, if additional staff members are hired once a certain level of production is achieved, labor costs then become a "stepped" fixed cost, complicating classification. ▪ Semi-Variable Costs: ▪ These costs have elements of both fixed and variable costs. For instance, machinery maintenance might involve a fixed monthly fee plus additional costs depending on usage or the number of breakdowns. ▪ Time Frame: ▪ The classification of costs can depend on the time frame considered. For instance, salaries might be considered fixed in the short term because employees draw the same salary each month, but in the long term, these could vary based on business scale and needs, thus becoming more variable. ▪ © 2024 All rights reserved, University of Michigan  Fixed and Variable Costs - Not that easy to always distinguish ▪ Cost Allocation: ▪ Allocating indirect costs such as administrative overhead, office supplies, or support services can be challenging as these costs are not directly attributable to a specific unit of production. Determining how to allocate these costs appropriately can complicate the differentiation. ▪ Economies of Scale: ▪ As production increases, some variable costs per unit might decrease due to economies of scale. Conversely, some fixed costs can become variable if production scales up significantly and additional resources or expenses are needed. ▪ Revenue-Linked Costs: ▪ In some cases, costs might be linked to revenue rather than production levels. For example, sales commissions are typically tied to revenue and not strictly to the volume of units sold. © 2024 All rights reserved, University of Michigan  Price Setting - Market Approach ▪ Use the existing market price ▪ Higher price than nearest competitor ▪ What does it signal about quality? ▪ Lower price than nearest competitor ▪ What does it signal about quality? ▪ At or near price of nearest competitor ▪ What about the competitors brand loyalty © 2024 All rights reserved, University of Michigan  Price Discrimination Price discrimination is defined as the practice of charging different prices to different customers for the same product or service, where the price differences are not justified by corresponding differences in cost. The strategy aims to capture consumer surplus and maximize a firm's revenue by aligning prices more closely with individual consumers' willingness to pay. In of itself, there is not an issue with price discrimination © 2024 All rights reserved, University of Michigan  Price discrimination Examples ▪ Airline Tickets: Airlines often charge different prices for the same seat based on booking time, refund flexibility, and customer characteristics such as business vs. leisure travelers. ▪ Movie Theaters: Offer discounted tickets for students and senior citizens while charging full price for general admission. ▪ Software Licenses: Provide special pricing tiers for educational institutions, students, and businesses. © 2024 All rights reserved, University of Michigan  Discriminatory Pricing Behavior Price discrimination can sometimes cross into illegal territory if it violates antitrust laws, consumer protection regulations, or anti-discrimination laws. Examples include: Price fixing, predatory pricing, discrimination based on protected characteristics, price gouging, © 2024 All rights reserved, University of Michigan © 2024 All rights reserved, University of Michigan © 2024 All rights reserved, University of Michigan © 2024 All rights reserved, University of Michigan  Illegal Price Discrimination In your teams ▪ Why does it happen? ▪ What practices can be implemented to prevent it? Be ready to share your conclusions © 2024 All rights reserved, University of Michigan