Internal method of pricing
- Cost plus/target pricing
- A simple way to arrive at a sales price by adding a mark-up to the cost of a product.
- Need to determine the break-even price/total price, which is the sum of all the expenses involved in creating a product (determine objective based on the scenario)
- Need to determine the target/profit goal
- Applies to product and services
- Drawbacks: ignores price strategies of competitors and role of customers
External methods of pricing
Competition based
Consumer demand based
Auction based
Value based
Competition based pricing
deciding how much to charge depending on what the competition charges.
Head on pricing
Charge exactly the same price as competitor
Differential pricing
decision to lower or increase the price vs. competition based on strategic objectives
Competition based pricing advantages
intuitive appeal about how consumers might think
Competition based pricing disadvantages
does not take into account competitors’ internal cost structures (some competitors may have much higher efficiencies to lower price even further). Most times, you don’t know how competition can set prices.
Consumer demand based pricing
- Charge as much as the “market will bear” - start with charging a certain price, adjust as you go along.
- Success depends on the ability of marketers to analyse the demand
- This type of pricing can be seen in the hospitality and travel industries. For instance, airlines during the period of low demand charge less rates as compared to the period of high demand.
Auction based pricing
Prices are determined by bidding customers
- English (ascending): one seller, many buyers
- Dutch (descending): one buyer, many sellers
- Sealed bid: participants don’t know each others’ bid
Auction based pricing advantages
Real time price discovery
Auction based pricing disadvantages
May alienate customers, can be risky
Value based pricing
the method of setting a price by which a company calculates and tries to earn the differentiated worth of its product for a particular customer segment when compared to its competitor
Value based pricing considerations
- Focus on a single segment
- Compare with next best alternative: ask the question - “what would this segment buy if my product wasn’t available?” Value based pricing methodology not suitable for truly new products
- Understand differentiated worth: which product features are unique, that is differentiated, from the competitor’s offering.
- Place a dollar amount on the differentiation.
Best solution to pricing method
- Mixed methods: taking into account both external (macro environment, competitors and customers) and internal factors
- Setting the price point: use various methods and sources of information together to arrive at a final pricing strategy, your final number
Price premium purpose
To evaluate pricing in the context of market competition
Benchmark price can be
- Price of a specified competitor: simple price by competitor.
- Average price paid: unit sales weighted average of competitor prices
Average price charged: unweighted average of competitor prices.
Average price displayed: average weighted to distribution (numeric, PCV, ACV)
Average price paid
- Requires knowledge of ales or shares of each competitor
- Changes in unit prices/ shares will affect the average price paid
Average price charged
- Requires knowledge of prices and not the shares of each competitor; hence not impacted by changes in unit shares
- Captures how brand compares to prices set by competitors without regard to brands share; hence all competitors are weighted equally.
Average price displayed
- Managers who seek a benchmark that captures differences in the scale and strength of brands’ distribution might weight each brand’s price in proportion to a numerical measure of distribution
- Typical measures of distribution strength include numeric distribution, ACV (%) and PCV (%).
- Sum of weighted prices of each brand to be divided by the total weighting for the average price.
Price premium problems
- Competitors: who are they? Should we include own price, just leading competitors, all?
- Should we use manufacturer, distributor or retail prices?
- Prices can be calculated net (discounts, rebates, coupons deducted) or gross
Role of demand curves and price elasticity
- The purpose of these metrics is to bring consumer information into the pricing process
- This group of metrics is based on microeconomic theory
- The theoretical models need to be estimated by empirical measurements
Price Elasticity of Demand
- PED measures the responsiveness of demand after a change in a product’s own price. Expressed as a ratio percentage % change in quantity for a small % change in a price.
- In markets that are unresponsive to price changes, demand is inelastic
- If minor price changes have a major impact on demand, we say demand is elastic
- Elasticity becomes more negative - as price increases.
- Elasticity varies not only between different goods, but also along the demand curve for any specific good using a straight-line demand curve.
- PED will go from infinity to zero with unit elasticity in the middle
Price elasticity of demand purpose
to understand market responsiveness to a small change in price
Price elasticity of demand considerations
- PED will almost always be a negative number indicating that when prices increases, the quantity demand is expected to decline and vice versa.
- When demand is linear, elasticity changes with price
