Transcript Slide 1

Pricing
Introduction: Economics & Price Techniques
Stephan Sorger: www.stephansorger.com
Disclaimer:
• All images such as logos, photos, etc. used in this presentation are the property of their respective copyright
owners and are used here for educational purposes only
• Some material adapted from: Nagle et al, “The Strategy and Tactics of Pricing,” 5th Edition
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Introduction to Economics
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The Economic Problem
• Unlimited Wants
• Scarce Resources –
Land, Labor, Capital
• Resource Use
• Choices
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
The Economic Problem
• What goods and services should an economy
produce?
– should the emphasis be on agriculture, manufacturing or
services, should it be on sport and leisure or housing?
• How should goods and services be produced?
– labor intensive, land intensive, capital intensive?
• Who should get the goods and services produced?
– even distribution? more for the rich? for those who work
hard?
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Opportunity Cost
•Definition – the cost expressed in terms
of the next best alternative sacrificed
•Helps us view the true cost of decision
making
•Implies valuing different choices
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Free Market Economy
•Self regulating
•Self-interest- Sellers want to make the
most money possible
•Competition- Prices should be as high
as possible, while still competitive
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Supply Curve
The more we produce the more it
costs to produce
Supply
Schedule
Price
1
2
3
4
5
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Q
12
28
42
52
60
Demand Curve
The higher the price of an item the
lower its demand
Demand
Schedule
Price
5
4
3
2
1
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Q
10
17
26
38
53
Supply/Demand Curve
Maximize profits and fill demand
Supply meets demand exactly
=
Max profit and sales
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Microeconomics
•Micro
•Micro comes from Greek word mikros, meaning “small”
•Microeconomics
•Study of behavior of individual households, firms, and
governments
•Choices they make
•Interaction in specific markets
•Focuses on individual parts of an economy, rather than the whole
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Macroeconomics
•Macro
•Macro comes from Greek word, makros, meaning “large”
•Macroeconomics
•Study of the economy as a whole
•Focuses on big picture and ignores fine details
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Production Possibility Frontier (PPF)
•Production – output of goods and services
•Possibility – maximum attainable amount
•Frontier – border or boundary
•PPF shows the boundary of what is possible and is used as an illustration
in economics to show the choices facing all countries in producing goods
which use limited factors of production.
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Production Possibility Frontier
• Show the different combinations of goods and services that can be
produced with a given amount of resources
• No ‘ideal’ point on the curve
• Any point inside the curve – suggests resources are not being
utilised efficiently
• Any point outside the curve – not attainable with the current level of
resources
• Useful to demonstrate economic growth and opportunity cost
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Production Possibility Frontier
• Assume a country can produce two types of goods with its
resources – capital goods and consumer goods
• No ‘ideal’ point on the curve
• Any point inside the curve – suggests resources are not being
utilised efficiently
• Any point outside the curve – not attainable with the current level of
resources
• Useful to demonstrate economic growth and opportunity cost
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Production Possibility Frontier
Ym
Yo
A
Capital
Goods
Y1
B
1. Assume a country can
produce 2 types of goods
-Capital goods and consumer
goods (Guns & Butter)
2. At point A on the curve, it
produces Y0 capital goods
and X0 consumer goods
3. If it devotes all resources to
capital goods it can do Ym
4. If it devotes all resources to
consumer goods it can do Xm
5. The opportunity cost of
producing an extra X0-X1 of
consumer goods is Y0-Y1 of
capital goods
Xo
X1 Xm Consumer Goods
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Production Possibility Frontier
C
Y1
Yo
Capital
Goods
.
A
B
Xo X1
1. It can only produce at points
outside the PPF if it finds a way
of expanding its resources or
improves the productivity of the
resources it already has. This
will create a new bigger PPF
2. The new frontier takes us
from point A to point C
3. At point B, we are not utilizing
all of our available resources
Consumer Goods
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Demand Curves
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Demand Curves: Elastic
Elasticity = (Percentage change in quantity demanded)
(Percentage change in price)
Demand Curve
Elastic Demand: Elasticity > 1
Price high  Purchase fewer items
Price
Price low  Purchase more items
Quantity
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Demand Curves: Inelastic
Demand Curve
Inelastic Demand: Elasticity < 1
Almost same quantity, regardless of price
Price
Quantity
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Demand Curves: Elasticity
Price
Quantity
$10
5
$20
4
$30
3
$40
2
$50
1
(P1, Q1) = ($10, 5)
(P2, Q2) = ($50, 1)
Elasticity = (Percentage change in quantity demanded)
(Percentage change in price)
= [ (Q2 – Q1) / Q1 ] / [ (P2 – P1) / P1 ]
= [ (1 – 5 ) / 5 ] / [ ( $50 - $10 ) / $10 ] = -0.80 / 4 = -0.20
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Demand Curves: Optimal Pricing
Price
Quantity
Revenue
Cost
Profit
$10
5
$10 * 5 = $50
$20 * 5 = $100 $50 - $100 = ($50)
$20
4
$20 * 4 = $80
$20 * 4 = $80
$80 - $80 = $0
$30
3
$30 * 3 = $90
$20 * 3 = $60
$90 - $60 = $30
$40
2
$40 * 2 = $80
$20 * 2 = $40
$80 - $40 = $40 *
$50
1
$50 * 1 = $50
$20 * 1 = $20
$50 - $20 = $30
Optimal Pricing Table for Product
Max. profit at $40
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Pricing Techniques
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Pricing Techniques:
Creaming Pricing
“Skim the cream off the top of the market”
Market
Creaming
Price
Approach: Set prices high during introduction of new product
Usage: Use to recover high initial development costs
Example: Panasonic set high prices for its new 3D TVs
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Pricing Techniques:
Demand Pricing
Demand Curve
Demand-Based
Price
Price
Quantity
Approach: Set prices to maximize profit, based on demand
Usage: Use to maximize profits in dynamic markets
Example: Amazon.com adjusts its prices over time
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Pricing Techniques:
Everyday Low Pricing
Steady Prices
Deep Discounts
Everyday
Low Price
Approach: Set prices consistently low to attract bargain shoppers
Usage: Use to reduce spike-based supply chain costs
Example: Walmart uses EDLP to emphasize value
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Pricing Techniques:
Going Rate Pricing
Competitor 1
Competitor 2
Going Rate
Going Rate
Price
Competitor 3
Approach: Set prices to align with those of its competitors
Usage: Use when in an inferior position to competitors
Example: Gas stations in same area sell at same price
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Markup/ Cost-Plus
Unit Cost
Percentage: %
Markup/
Cost Plus
Price
Approach: Set prices by adding percentage to unit cost
Usage: Use to ensure costs are being covered
Example: Consumer packaged goods use markup
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Markup/ Cost-Plus
Unit Cost = (Variable Cost) + (Fixed Cost) / (Unit Sales)
Variable Cost = Cost of labor & materials to manufacture each unit
Fixed costs = Costs that remain fixed as we increase the number of units manufactured
Unit Sales = Quantity of units that we sell
Markup Price = (Unit Cost) / (1 – Markup Percentage)
Example
Variable cost = $10 per bulb; Fixed costs = $400,000; Unit sales estimate = 40,000; Markup: 20%
Unit cost = ($10) + ($400,000) / (40,000) = $10 + $10 = $20 per bulb
Markup Price = ($20) / (1 – 0.20) = $25 per light bulb
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Penetration Pricing
Competitors
Penetration
Price
Company
Approach: Set prices low to attract new customers
Usage: Use to expand market share quickly
Example: P&G can set prices low to boost sales
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Prestige Pricing
Prestige
Brand
Prestige
Price
Set prices high to signal high quality or status
Usage: Use to maximize perceived brand equity
Example: Rolex sets prices high to signal good brand
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Target-Return Pricing
Target
Return
ROI
Target-Return
Price
Approach: Set prices to achieve company-defined rate of return
Usage: Use when company has internal “hurdle rate”
Example: Industrial supply companies
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Target-Return Pricing
Unit Cost = (Variable Cost) + (Fixed Cost) / (Unit Sales)
Variable Cost = Cost of labor & materials to manufacture each unit
Fixed costs = Costs that remain fixed as we increase the number of units manufactured
Unit Sales = Quantity of units that we sell
Target-Return Price = (Unit Cost) + (Target ROI) * (Investment) / (Unit Sales)
Example
Variable cost = $10 per bulb; Fixed costs = $400,000; Unit sales estimate = 40,000;
Investment = $800,000; Target ROI = 20%
Unit cost = ($10) + ($400,000) / (40,000) = $10 + $10 = $20 per bulb
Target-Return Price = ($20) + (20%) * ($800,000) / ($40,000) = $24
Tiered Pricing
Multiple Levels
Tiered Price
“Best” Level
Highest Price
“Better” Level
Medium Price
“Good” Level
Lowest Price
Approach: Set prices at different levels for different sets of features
Usage: Use to signal different quality levels
Example: Big O Tires offer Good Better Best oil change
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Value-In-Use Pricing
Perceived Value:
Existing Product/Service
Perceived Value:
Alternative Product/Service
Value-in-Use Price
Approach: Set prices based on product or service’s value to the customer
Usage: Use for B2B and high-value B2C; Especially for efficiency savings
Example: Rhino Shield ceramic coating lasts 25 years; “never paint again”
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Value-In-Use Pricing
Variable
Existing light bulbs: Price
Existing light bulbs: Life
Existing light bulbs: Labor
Existing light bulbs: Quantity
Acme LUX light bulbs: Price
Acme LUX light bulbs: Life
Acme LUX light bulbs: Labor
Data
$5
6 mo.
$20/unit
100
VIU
24 mo.
$20/unit
Description
Price of existing halogen light bulbs
Life expectancy in difficult conditions
Labor cost to replace light bulbs
Quantity of light bulbs to be replaced
Value in use price we wish to calculate
Life expectancy in difficult conditions
Labor cost to replace light bulbs
Annual Light Bulb Cost = Cost for Parts (Light Bulbs) + Cost of Labor (to Replace Light Bulbs)
= 100 light bulbs * $5/ each * 2 changes/ year + 100 light bulbs * $20/each * 2 changes/ year
= $1,000/ year + $4,000/ year = $5,000/ year
$5,000
= 100 light bulbs * $VIU/ each * 0.5 changes/ year + 100 light bulbs * $20/ each * 0.5 changes/ year
VIU = $80 each for the Acme LUX LED light bulb
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction
Variant Pricing
Segment 1: Budget-oriented
Variant Price 1: Offering for Segment 1
Segment 2: Convenience-oriented
Variant Price 2: Offering for Segment 2
Segment 3: Luxury-oriented
Variant Price 3: Offering for Segment 3
Segment 4: Selection-oriented
Variant Price 4: Offering for Segment 4
Segment 5: Time-oriented
Variant Price 5: Offering for Segment 5
Approach: Set different prices for different variants to segments
Usage: Target different market segments
Example: Volkswagen sells VW, Audi, Porsche, others
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Introduction