Pricing to cost vs. to value
Firms should price to value, not to cost.
Cost-based pricing is easy, while value-based pricing is hard.
Main factors while setting prices
- Competition and elasticity
- Ease of comparison
- Preferences / WTP
Pricing with elasticity information
Profit = (P-VC)*Q-FC
Finding optimal price:
Derivate of profit w.r.t. price equals zero
Ease of comparison
- With the rise of the internet price comparison became a lot easier
- Instead of equal prices, it was observed that companiers start not to give out their prices early on
- Information friction (make comparison more difficult) generate margins to firms
Preferences/WTP
- Preferences of consumers can be revealed through a Conjoint Analysis
- Consumers are shown different sets of features and are asked to rate them
- Can be used for measuring willingness to pay
Price penetration
Start with a low price and increase it over time. Very aggressive strategy, thus you need good reasons to do it. Increasing prices later on is tricky.
Motivations:
- Secure position
- Gain market share
- Switching costs
- Entry deterrence
- Network externalities
Price skimming
Start with a high price and reduce the price later on
Applicable if:
- high consumer heterogeneity (some customers are willing to pay a lot more than others)
- Durable products (customers buy only one unit)
- Requires high differentiation
Veblen goods
The appeal of the product increases if fewer people have it –> High price makes it more appealing
Price-quality inferences
Price is an indicator of quality if you have no other information about the different products.
- Consumer assert higher prices with higher quality
- These products in fact activate more pleasure senses in the brain
- Sunk costs matter: If consumers paid less, they value the product less
Promotional pricing
- By promotional pricing, you can make use of different WTP
- The idea is that consumers self-select into the promotion
- There must be some friction to the discount and not all customers will make the effort.
Leaky paywalls
A couple of articles are free before users have to pay for them
- retains flexibility
- allows for self-selection
- does not shut off search and social
