How to set the price?
- Competition and elasticity
- Ease of comparison: how easy is to compare price? Depending on how easy its product is to be compared with other products in the market, the company can command a higher price
- Preferences/WTP
The prices are dynamic, they change over time, what are two strategies of pricing?
Market-Penetration
Market Skimming
What is market-penetration pricing?
Starting with a low price, with the intent of increasing it over time.
- Attracts a large number of buyers
- Increase market share and secure position in the market.
- Occurs if there are network externalities - increased number of users improves the value of the product.
- Entry deterrence.
- High Switching costs.
What is market-skimming pricing?
Starting with a high price, with the intent of decreasing it over time.
- There are customers that are willing to pay much more than the others. We first get the customers with the higher WTP, and later on lower the price to capture the customers with lower WTP.
- It requires high differenciation and high consumer heterogeneity (iphone), we need to have customers that are willing to pay more than others.
- Durable products.
We should take consumer psychology into account. What are veblen goods?
Goods for which demand increases as the price increases. Goods that raises in appeal the fewer people have it - Conspicuous consumption, the practise of purchasing goods or services to publicly display wealth rather than to cover basic needs.
What is promotional pricing?
We introduce a barrier that makes it harder for some consumers to get the discount, this allows us to charge different prices to different segments.
Have the consumer self-select the discount by introducing a barrier for some consumers to get the discount
- Coupons, people need to search for it;
- Buy 1 get 1, people need to buy more than 1;
- Price matching, people need to search through stores;
- Temporary price cut, people need to purchase at the exact timing.
What is the difference between pricing to cost and to value?
Cost-Based Pricing (Easy): focuses on covering the costs associated with producing, distributing, and selling a product, with a margin added for profit.
Value-Based Pricing (Hard): focuses on determining the price based on the perceived value of the product or service to the customer.
Explain Competition and Elasticity
Elasticity: ε = (ΔQ/Q)/(ΔP/P) = ΔQ/ΔP × P/Q
- Elasticity usually has a negative sign, because if you increase prices you usually decrease quantity.
Optimal Price: (P − VC)/P = −1/ε′
- % Gross Margin = Negative of Inverse of Elasticity
If competition is considered, there will be a more complicated formula, with all rivals’ elasticities.
Explain Ease of Comparison
With the internet, prices would technically be all the same due to perfect price information. However, this is not the case.
Companies engage in price obfuscation practices by not giving away price information too soon to consumers.
This happens because information frictions generate margins for firms.
Firms try to obfuscate prices so that consumers don’t have perfect information, which allows them to command a higher price.
Explain Preferences/WTP
When doing price testing, a common practice is conjoint analysis.
Conjoint analysis works by asking users to directly compare different features to determine how they value each one.
When a company understands how its customers value its products or services’ features, it can use the information to develop its pricing strategy.
What are the different types of price discrimination?
Price discrimination
Promocional pricing
Leaky paywalls
What are leaky paywalls?
Type of online content access system that allows users to view a certain amount of content for free before requiring them to pay for additional access.
It allows companies to get money both from subscriptions and advertisers, as well as allowing for consumers to self-select if they want to pay for the product or not.
Define price discrimination.
Selling strategy that charges customers different prices for the same product or service based on what the seller thinks they can get the customer to agree to.
The seller places customers in groups based on certain attributes and charges each group a different price.
What is price bundling?
Combining multiple products or services into a single package and selling them at a unified price.
This approach offers customers the convenience of purchasing several items together, often at a lower combined cost than if they were to buy each item individually.
What’s the difference beween Contribution Margin and Gross Margin
Gross Margin = Revenue - COGS
Contribution Margin = Revenue - Variable Expenses
The primary difference is that gross margin is a total profit metric, whereas contribution margin is a per-item metric. That is, the former illustrates the profitability of the business as a whole, while the latter relates to the profitability of a particular product or service that the business makes.
