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Luiz Afonso dos Santos Senna - PhD

Pricing Strategies and Tactics


Luiz Afonso dos Santos Senna, PhD

lsenna@producao.ufrgs.br
Luiz Afonso dos Santos Senna - PhD
Fatores na fixao de Preo
Luiz Afonso dos Santos Senna - PhD
Fatores Externos afetando as decises de preos

Mercado e demanda
Custos definem o limite inferior e a demanda
define o limite de preo.
As relaes preo-demanda so fuindamentais
par aos teomadres de deciso em transportes
Fatores Externos incluem a natureza do mercado
e da demanda, competio e outros elementos
ambientais

Luiz Afonso dos Santos Senna - PhD
Preo em diferentes tipos de mercados

Mercados de Competio Pura
Bens/servios uniformes
No existe um nico vendedor ou comprador com
efeito significativo sobre o preo de mercado
Marketing mix possui pouco impacto

Luiz Afonso dos Santos Senna - PhD
Preo em diferentes tipos de mercados

Competio Monopolstica
Compradores e vendedores trocam sobre uma gama
de preos
nfase em diferenas por meio de diferenciao
atravs de marketing mix
Competio Oligopolstica
Poucos vendedores altamente sensveis aos preos
de cada um e de estratgias de marketing

Luiz Afonso dos Santos Senna - PhD
Consideraes primrias na fixao de preos
Objetivos de Pricing
Luiz Afonso dos Santos Senna - PhD
Cost-based versus value-based pricing
Source: The Strategy and Tactics of Pricing, by Thomas T. Nagle and Reed K. Holden (2011)
Preo baseado em custos X baseado em valor
Pricing, Competio e
Estrutura de Mercado

Luiz Afonso dos Santos Senna - PhD
How does our pricing strategy fit into this
framework? What economic principles apply?
Porters Five Forces Model (old)
Supplier Power
Substitutes and Complements
Internal Rivalry Buyer Power
New Entrants
Luiz Afonso dos Santos Senna - PhD
Market Structure Internal rivalry
Market structure and pricing decisions are closely
related. But how to define the market?
The degree to which the firm gets to choose price is
determined in large part by market structure
There are two extreme cases: perfect competition
and monopoly
Luiz Afonso dos Santos Senna - PhD
Assessing and responding to a competitors price cut (depending
on the market structure)
Luiz Afonso dos Santos Senna - PhD
Perfect Competition
Conditions necessary:
Large numbers of buyers and sellers
Homogeneous product
Free entry and exit
Perfect information
Luiz Afonso dos Santos Senna - PhD
Perfect Competition
Demand curve for any given firm is
horizontal. Price is set by market at P
e







Firm can sell as much or as little as desired
at market price, but nothing if they raise P.
P
e
S
D
D P
e
Luiz Afonso dos Santos Senna - PhD
Monopoly
Conditions necessary
Single seller of product
No close substitutes
Significant barriers to entry
There are few examples of perfect
competition and pure monopoly.
Most firms have a differentiated product, and
there are substitutes.
Luiz Afonso dos Santos Senna - PhD
Pricing in Perfect Competition
Do not choose price.
Choose output quantity. TC includes opportunity
cost of capital invested.
What will be our profit (loss) from our output
decision?
Should we produce now? (SR)
Should we stay in the industry? (LR)
Luiz Afonso dos Santos Senna - PhD
Costs at different levels of production
Cost per unit at different levels of production
Luiz Afonso dos Santos Senna - PhD
Pricing in a Monopoly
Profit maximization will be achieved by setting
price so that MC=MR.
It is not reached by setting price as high as
possible.
Like any firm, the monopolist is constrained
by their demand curve.
One cannot choose both P and Q.
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule
At what point should the firm cease
production of a certain item?
When might it pay to produce at a loss?
In SR, many costs are fixed. Just because a
firm is making losses, it does not necessarily
mean it should shut down (short run), or even
go out of business (long-run).
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule cont.
Profit = TR TC; TR=P*Q, TC = VC + FC
(TR - VC) - FC = [(P - AVC)Q] FC
Separate out fixed costs, focus on variable elements
As long as P>AVC, there is a positive contribution to
fixed costs.
If firm shuts down (Q = 0), then Profit = - FC
If shut down: Firm has a loss of fixed costs.
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule cont.
In SR, firm may minimize losses by continuing to
produce.
If losses are expected permanently, get out.
Case of multiple products:
C = FC + VC
1
+ VC
2
Luiz Afonso dos Santos Senna - PhD
The Shut-Down Rule
1. P = (TR
1
- TVC
1
) + (TR
2
- TVC
2
) - FC
2. P = (P
1
*Q
1
- AVC
1
*Q
1
) + (P
2
*Q
2
- AVC
2
*Q
2
) - FC
3. P = [(P
1
- AVC
1
)*Q
1
]+ [(P
2
- AVC
2
)*Q
2
] - FC
Results:
1. SR - each product should be produced if P
i
>AVC
i

2. In LR, the firm should continue operating only if
expected P>=0 (Profits are non-negative)
Luiz Afonso dos Santos Senna - PhD
Price Discrimination
Selling the same good to different people at
different prices
Conditions necessary:
Identifiable customer groups with differing price
elasticities
Maintain separation of groups--prevent resale.
Luiz Afonso dos Santos Senna - PhD
Types of Price Discrimination
First degree
Identify and charge each customer
what they are willing to pay
Limit: D = MR, no consumer
surplus.
Second degree
Quantity discounts. Volume
purchases are given lower prices.
Need to measure goods and
services bought by consumers.
Luiz Afonso dos Santos Senna - PhD
Types of Price Discrimination
Third degree
Segment markets in some way. Charge
all in the segment the same prices.
Treat each segment as a separate
market then do MR=MC in each
Are coupons as a price discrimination
mechanism?
Luiz Afonso dos Santos Senna - PhD
Oligopoly Strategies
Common theme - Rivalrous behavior
Pricing - limit pricing - set prices low as signal
to possible entrants or other competitors your
willingness and ability to defend your market
share.
Must have credibility.
Trading SR profit for more profits later
Luiz Afonso dos Santos Senna - PhD
Oligopoly Strategies
Use the legal / regulatory systems
File patent application
Challenge business charter application
File regulatory challenge
Pre-emptive entry - Wal-Mart
Luiz Afonso dos Santos Senna - PhD
Oligopoly Strategies
Capacity and production
Announce capacity expansion
Revise/modify products - more
difficult to copy
Advertising
Raise cost of entry for others
Luiz Afonso dos Santos Senna - PhD
Oligopoly and Monopolistic Competition
Oligopoly
Few sellers - usually large ones
Recognized interdependence in
pricing and output decisions
Need to consider response of rivals in
pricing decisions
Typically significant barriers to entry
Luiz Afonso dos Santos Senna - PhD
Oligopoly and Monopolistic Competition
Monopolistic Competition
Large number of interdependent
sellers
Differentiated product
Good substitutes
Easy entry and exit
Luiz Afonso dos Santos Senna - PhD
Oligopoly and Monopolistic Competition
Most industries are one or the other
Oligopoly: many heavy manufacturing
Autos, steel, chemicals, pharmaceuticals
Monopolistic Competition
Service companies, retail stores, large
corporations (McDonalds, Wendys)
The important point is that demand is downward
sloping
Luiz Afonso dos Santos Senna - PhD
Cartels
Illegal in most countries but encouraged in
others
Conditions helpful:
Small number of firms
Homogeneous product
Entry barriers
Similarity of members
Luiz Afonso dos Santos Senna - PhD
Cartels
Problems with cartels:
Cheating on agreement
Price cutting behaviour
Tend to fall apart
Note: When might firms in an industry ask for
(demand) regulation?
Luiz Afonso dos Santos Senna - PhD
Pricing Strategies
Profit maximizing rule:
Set production at level where MR = MC
Non - Maximizing pricing rules
there are a variety of these
Luiz Afonso dos Santos Senna - PhD
Pricing for Multi-Product Firm
Two products, x and y. TR
firm
= TR
x
+ TR
y
If there are any spillovers from x to y, then you
may get complications.
MR =
TR
Q
TR
Q
TR
Q
x
x
x
x
y
x
d
d
d
d
d
d
=
MR =
TR
Q
TR
Q
TR
Q
y
y
y
y
x
y
d
d
d
d
d
d
=
Luiz Afonso dos Santos Senna - PhD
Multi-Product Firm cont.
The two terms on the right side of the
equation represent interactions. They can be
either positive or negative.
If x and y are complementary goods, the
effect is positive.
If x and y are substitutes, the effect is
negative. One units gain is the others loss.
Luiz Afonso dos Santos Senna - PhD
Two part pricing
Charge P = MC
charge a fixed fee to extract some of the
consumer surplus
Examples:
country clubs
health clubs
electricity providers
Luiz Afonso dos Santos Senna - PhD
Declining block pricing
Charging different prices according to how
much is purchased
Attempt to extract consumer surplus and
transfer value to company

Luiz Afonso dos Santos Senna - PhD
Auction pricing models
Standard auction model
multiple bidders compete with each other
start at some low price, then successive bids
raise price until someone wins
Dutch auction model
start at a high price, lower it until someone bids
ex: dutch flower auctions
How to extract consumer surplus?

Luiz Afonso dos Santos Senna - PhD
How does the development of online business
affect this analytic tool? How does the Internet
change the economic principles that apply?
Porters Five Forces Model
Supplier Power
Substitutes and Complements
Internal Rivalry Buyer Power
New Entrants
Luiz Afonso dos Santos Senna - PhD
Market structure and the Internet
Traditional industry structure paradigm?
Structure, time and place?
Firm size, customer access and service?
Pricing, and reputation online
Who is competing with whom?

Luiz Afonso dos Santos Senna - PhD
Luiz Afonso dos Santos Senna - PhD
Internet and demand issues
Role of customer service and customer loyalty
online: e-loyalty?
Consumer demand issues - which goods to
buy online, which in person?
How to price online?
Does this signal the end of the Brand?


Luiz Afonso dos Santos Senna - PhD
Pricing and the Internet
Traditional pricing paradigm?
Access to demand data...
Measurement of demand elasticities?
Ability to conduct pricing experiments
Ability to spot market changes - and
move quickly (perhaps)
Access to bigger customer base
Will prices be lower online?
Luiz Afonso dos Santos Senna - PhD
Firm structure and the Internet
Are traditional firm structure concepts now
irrelevant?
Economies of scale? Scope?
How does this affect firm incentives to
vertically integrate (or de-integrate)?
Central role of transaction costs...

Luiz Afonso dos Santos Senna - PhD
The Determinants of Demand
Demand The relationship between the
quantity of a good desired by people in a
market and the factors that affect that the
quantity desired is referred to as the
demand for the product. We can express
the demand for a product in the form
We have some precise definitions related
to how income and prices of other goods
affect the demand for a good/service


Luiz Afonso dos Santos Senna - PhD
Factors that we expect to affect the demand for the good include:
Population (n)
Price of the good (p
i
)
Price of other goods (p
j
)
Income (y)
Expectations of future prices
Tastes (T)

Luiz Afonso dos Santos Senna - PhD
Substitutes and Complements
Two goods, x and y, are said to be substitutes if an
increase in the price of x (y) increases the demand for
good y (x) and a decrease in the price of x (y)
decreases the demand for y (x) (Butter and
margarine)
Two goods, x and y, are said to be complements if
an increase in the price of x (y) decreases the demand
for good y (x) and a decrease in the price of x (y)
decreases the demand for y (x) (Sugar and coffee)

Luiz Afonso dos Santos Senna - PhD
Income and Demand

A good is said to be normal if an increase
(decrease) in income increases (decreases) the
demand for the good. A good is said to be
inferior if an increase (decrease) in income
decreases (increases) the demand for a good
Luiz Afonso dos Santos Senna - PhD
The Demand Curve
The relationship between the quantity demanded of a good and the
price of that good is referred to as the demand curve.
Luiz Afonso dos Santos Senna - PhD
Figure 5
0
1
2
3
4
5
6
7
8
9
10
0 10 20 30 40 50 60 70 80 90 100
Quantity
P
r
i
c
e

(
$
)
D
Luiz Afonso dos Santos Senna - PhD
The demand curve gives the relationship
between price and the quantity consumers
will desire to purchase at that price
Note the demand curve is drawn given that
no other factors affecting the demand for
the product, such as income, population, or
tastes, change
Demand for the product is based on
specific, unchanging values for the other
factors that affect demand

Luiz Afonso dos Santos Senna - PhD
As the price of a good decreases (increases),
more (less) of it will be purchased
That is, the demand curve is downward sloping
There are two factors that explain this
relationship:
As the price of a good increases, consumers will substitute into
other goods (substitution effect);
.As the price of a good increases, consumers will have less real
income to purchase all goods (income effect).

The Law of Demand
Luiz Afonso dos Santos Senna - PhD
Changes in Demand versus Changes in Quantity
Demanded
A movement along a demand curve is referred to as a change in
quantity demanded.
The quantity demanded changes because of a price change.
A shift in the demand curve is referred to as a change in demand.
Demand changes (the demand curve shifts) because of a change in
one of the factors affecting demand other than price (income, price
of other goods, tastes, population) changes.
Luiz Afonso dos Santos Senna - PhD
Demand for steaks
D
1
represents the demand for steaks (lbs/day) given the price of
chicken is $3.50; the number of customers is 1,500 a day; and the
average annual household income is $40 thousand.
Then we might expect the following:
A decrease in demand for steak if the price of chicken, a substitute for steak, fell
from $3.50 to $2.00.
This is shown by a shift in of the demand curve from D
1
to D
2

An increase in demand for steak if the annual income increases from $40 to $60
thousand, since steak is a normal good.
This is shown by a shift out of the demand curve from D
1
to D
3


Luiz Afonso dos Santos Senna - PhD
Figure 1
0
1
2
3
4
5
6
7
8
9
10
0 10 20 30 40 50 60 70 80 90 100
Quantity
P
r
i
c
e

(
$
)
D
Luiz Afonso dos Santos Senna - PhD
0
1
2
3
4
5
6
0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000
P
r
i
c
e

(
$
/
l
b
)
Quantity (lbs of Steak/Day)
D
1
D
2
D
3
D
4
Luiz Afonso dos Santos Senna - PhD
Algebraic Representation
The preceding figure that follows is given by
Q
D
= 100 - 10P
Linear relationship we can graph by choosing two
points.
Easiest points:
Q = 0 0 = 100 - 10P or P = 10, Q = 0
P = 0 implying Q = 100 - 10(0) = 100 and therefore
P = 0, Q = 100
Slope, dQ/dP = -10

Luiz Afonso dos Santos Senna - PhD
The Determinants of Supply
Number of Firms
Price of Product
Cost of inputs
Wages
Capital
Materials
Price of other goods
Expectations of Future Prices
Technology
Luiz Afonso dos Santos Senna - PhD
The Supply Curve
The relationship between the quantity supplied of a good
and the price of that good is referred to as the supply curve
The supply curve gives the relationship between price
and the quantity produces will wish to sell at that price
Note the supply curve is drawn given that no other factors
affecting the supply for the product
Supply of the product is based on specific, unchanging
values for the other factors that affect supply

Luiz Afonso dos Santos Senna - PhD
Figure 3
0
2
4
6
8
10
12
14
16
0 10 20 30 40 50 60 70 80 90 100
Q
$
S
Luiz Afonso dos Santos Senna - PhD
The Law of Supply
As the price of a good increases (decreases), more (less) of it will be
produced and offered for sale.
The supply curve is upward sloping.
This is explained by the assumption that marginal (incremental) cost
increases as output increases.

Luiz Afonso dos Santos Senna - PhD
Changes in Supply versus Changes in Quantity
Supplied
A movement along a supply curve is referred to as a
change in quantity supplied.
The quantity supplied changes because of a price
change.
A shift in the supply curve is referred to as a change
in supply.
Supply changes (the supply curve shifts) because of a
change in one of the factors affecting supply other
than price changes.
Luiz Afonso dos Santos Senna - PhD
Comparisons
What happens to Price & Quantity when:
Incomes increase
Wages fall
Prices of other goods change
Making predictions of the impact on the market of these types of
changes is referred to as Comparative Statics


Luiz Afonso dos Santos Senna - PhD
Comparisons
These changes are all changes in demand or changes in
supply
Shifts in demand or supply curve
4 possibilities:
Increase in demand (shift out demand curve)
Decrease in demand (shift in demand curve)
Increase in supply (shift out supply curve)
Decrease in supply (shift in supply curve)

Luiz Afonso dos Santos Senna - PhD
The Impact of Market Condition Changes on Equilibrium Price and
Quantity
Market
Change
Impact on
Equilibrium
Price
Impact on
Equilibrium
Quantity
Examples
Increase in
Demand
+ + Increase in Income (normal
good); increase in price of
substitute; decrease in price
of complements; increase in
population
Decrease
in Demand
- - Opposite of increase in
demand
Increase in
Supply
- + Technological innovation;
increase in suppliers;
decreases in costs
Decrease
in Supply
+ - Increase in costs or wages;
increase in price of
alternative product produced
by firms

Luiz Afonso dos Santos Senna - PhD
Pricing Strategy
How does a company decide what price to
charge for its products and services?
What is the price anyway? doesnt price
vary across situations and over time?
Some firms have to decide what to charge
different customers and in different
situations
They must decide whether discounts are
to be offered, to whom, when, and for what
reason
Luiz Afonso dos Santos Senna - PhD
Why is Pricing Important?
In a company with average economics*,
1% increase in volume = 3.3% increase in
profit
1% increase in price = 11.1% increase in
profit
Improvements in price typically have 3-4
times the effect on profit as proportionate
increases in volume.

*Based on average of 2,463 companies
Luiz Afonso dos Santos Senna - PhD
Price vs. Nonprice Competition
In price competition, a seller regularly offers
products priced as low as possible and
accompanied by a minimum of services
In non price competition, a seller has
stable prices and stresses other aspects of
marketing
With value pricing, firms strive for more
benefits at lower costs to consumer
With relationship pricing, customers have
incentives to be loyal-- get price incentive if
you do more business with one firm
Luiz Afonso dos Santos Senna - PhD
Nonprice Competition
Some firms feel price is the main competitive
tool, that customers always want low prices
Other firms are looking for ways to add
value, thereby being able to avoid low prices
Sometimes prices have to be changed in
response to competitive actions
Many firms would prefer to engage in non
price competition by building brand equity
and relationships with customers
Luiz Afonso dos Santos Senna - PhD
SELECT PRICING OBJECTIVE
SELECT METHOD OF DETERMINING THE BASE PRICE:
Cost-plus
pricing
Price based on
both demand
and costs
Price set in
relation to
market alone
DESIGN APPROPRIATE STRATEGIES:
Price vs. nonprice
competition
Skimming vs.
penetration
Discounts and allowances
Freight payments
One price vs.
flexible price
Psychological pricing
Leader pricing
Everyday low vs.
high-low pricing
Resale price
maintenance
The Process: An Illustration
Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Establish Pricing
Objectives
Increase sales
volume?
Prestigious image?
Increase market
share?
Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Study Costs
Can you make a
profit?
Can you reduce
costs without
affecting quality or
image?

Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Estimate Demand
What do customers
expect to pay?
Prices usually are directly
related to demand.
Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Study Competition

Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Decide on a
Pricing Strategy
Price higher than the
competition because
your product is
superior
Price lower, then raise
it once your product is
accepted
Luiz Afonso dos Santos Senna - PhD
Steps for Determining Prices
Set Price
Monitor and evaluate its effectiveness
as conditions in the market change
Luiz Afonso dos Santos Senna - PhD
Pricing Technology
Smart Pricing decisions are based on an
enormous amount of data that Web-based
pricing technology crunches into timely, usable
information.
Communicating Prices to Customers electronic
gadgets that provide real-time pricing information
such as electronic shelves, digital price labels
Luiz Afonso dos Santos Senna - PhD
Pricing Technology
RFID Technology wireless technology that
involves tiny chips imbedded in products.
The chip has an antenna, a battery, and a
memory chip filled with a description of the
item
Toll technology

Luiz Afonso dos Santos Senna - PhD
Geographic Considerations
FOB (free on board) plant or FOB origin:
Price quotation that does not include shipping
charges. Buyer pays all freight charges to
transport the product from the manufacturer
Freight absorption: system for handling
transportation costs under which the buyer may
deduct shipping expenses from the costs of
goods
Geographic Considerations
Luiz Afonso dos Santos Senna - PhD
Uniform-delivered price: system for handling
transportation costs under which all buyers are
quoted with the same price, including transportation
expenses
Zone pricing: system for handling transportation
costs under which the market is divided into
geographic regions and a different price is set in
each region
Basing-point system: system for handling
transportation costs in which the buyers costs
included the factory price plus freight charges from
the basing-point city nearest the buyer. Seeks to
equalize competition between distant marketers
Product and Pricing
Strategies
Luiz Afonso dos Santos Senna - PhD
Types
of Products
Stages
of Products
Product Characteristics
Luiz Afonso dos Santos Senna - PhD
Other Pricing Strategies
Price-Based
Optimization
Skimming
Penetration
Luiz Afonso dos Santos Senna - PhD
Price Adjustment Strategies
Discount Pricing
Bundling
Dynamic Pricing
Luiz Afonso dos Santos Senna - PhD
Pricing Strategies
Luiz Afonso dos Santos Senna - PhD
Penetration Pricing
Luiz Afonso dos Santos Senna - PhD
Penetration Pricing
Price set to penetrate the market

Low price to secure high volumes

Typical in mass market products chocolate bars,
food stuffs, household goods, etc.

Suitable for products with long anticipated life cycles
May be useful if launching into a new market

Luiz Afonso dos Santos Senna - PhD
Market Skimming
Luiz Afonso dos Santos Senna - PhD
Market Skimming
High price, Low volumes

Skim the profit from the market

Suitable for products that have
short life cycles or which will
face competition at some point
in the future (e.g. after a patent
runs out)

Examples include: Playstation,
jewellery, digital technology,
new DVDs, etc.

Luiz Afonso dos Santos Senna - PhD
Market Skimming
Many are predicting a firesale in
laptops as supply exceeds demand
Plasma screens: Currently at
high prices but for how long?

Title: Thin-shaped television. Copyright: Getty Images,
available from Education Image Gallery
Luiz Afonso dos Santos Senna - PhD
Value Pricing
Luiz Afonso dos Santos Senna - PhD
Value Pricing
Price set in accordance with
customer perceptions about
the value of the product /
service

Examples include status
products/exclusive products
Companies may be able to set prices
according to perceived value.

Title: BMW At The Frankfurt Auto Show. Copyright:
Getty Images, available from Education Image Gallery


Luiz Afonso dos Santos Senna - PhD
Loss Leader
Luiz Afonso dos Santos Senna - PhD
Loss Leader
Goods/services deliberately sold below cost to
encourage sales elsewhere

Typical in supermarkets, e.g. at Christmas, selling
bottles of gin at 3 in the hope that people will be
attracted to the store and buy other things

Purchases of other items more than covers loss on
item sold
e.g. Free mobile phone when taking on contract
package
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Used to play on consumer perceptions

Classic example - $9.99 instead of $10.00!

Odd-even: $5.95, $.79, $699 OR $12, $50

Multiple Unit-3 for !1.00 better than $.34 each
Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Odd-Even Pricing
Odd numbers convey a bargain
image -- $.79, $9.99, $699


Even numbers convey a quality
image -- $10, $50, $100

Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Prestige Pricing sets a higher than
average price to suggest status

Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Multiple-Unit Pricing 3 for $.99
Suggests a bargain and helps
increase sales volume.
Better than selling the same items
at $.33 each.

Luiz Afonso dos Santos Senna - PhD
Psychological Pricing
Everyday Low Prices (EDLP)
set on a consistent basis
Luiz Afonso dos Santos Senna - PhD
Going Rate (Price Leadership)
Luiz Afonso dos Santos Senna - PhD
Going Rate (Price Leadership)
In case of price leader, rivals have difficulty in competing on
price too high and they lose market share, too low and the
price leader would match price and force smaller rival out of
market

May follow pricing leads of rivals especially where those rivals
have a clear dominance of market shar

Where competition is limited, going rate pricing may be
applicable banks, petrol, supermarkets, electrical goods find
very similar prices in all outlets
Luiz Afonso dos Santos Senna - PhD
Tender Pricing
Luiz Afonso dos Santos Senna - PhD
Tender Pricing
Many contracts awarded on
a tender basis

Firm (or firms) submit their
price for carrying out the
work

Purchaser then chooses
which represents best value

Most government contracts A European consortium led by Airbus
recently won a contract to supply
refuelling services to the RAF priced
at 13 billion!
Luiz Afonso dos Santos Senna - PhD
Price Discrimination
Luiz Afonso dos Santos Senna - PhD
Price Discrimination
Charging a different price for
the same good/service in
different markets

Requires each market to be
impenetrable

Requires different price
elasticity of demand in each
market
Air/rail
First class
Business class
Economy class

Prices for rail travel differ for the same
journey at different times of the day

Luiz Afonso dos Santos Senna - PhD
Discounts and Allowances
Cash Discounts offered to
buyers to encourage them to pay
their bills quickly.
2/10, net 30
Quantity Discounts offered for
placing large orders
Trade Discounts the way
manufacturers quote prices to
wholesalers and retailers.
Luiz Afonso dos Santos Senna - PhD
Promotional Pricing -- Used with sales
promotion
Loss Leader Pricing offering very
popular items for sale at below-cost
prices
Special-Event
Back-to-school specials
Dollar days
Anniversary sales
Rebates and Coupons




Luiz Afonso dos Santos Senna - PhD
Discounts and Allowances
Seasonal Discount offered
outside the customary buying
season

Luiz Afonso dos Santos Senna - PhD
Discounts and Allowances
Allowances go directly to the
buyer. Customers are offered a
price reduction if they sell back an
old model of the product they are
purchasing

Luiz Afonso dos Santos Senna - PhD
Destroyer Pricing/Predatory Pricing
Luiz Afonso dos Santos Senna - PhD
Destroyer/Predatory Pricing
Deliberate price cutting or
offer of free gifts/products to
force rivals (normally smaller
and weaker) out of business
or prevent new entrants

Anti-competitive and illegal if
it can be proved

Typical of oligopoly with
collusion
Microsoft have been accused of predatory
pricing strategies in offering free software as
part of their operating system Internet
Explorer and Windows Media Player - forcing
competitors like Netscape and Real Player out
of the market
Luiz Afonso dos Santos Senna - PhD
114
The Legality and Ethics of
Price Strategy

Issues
That Limit
Pricing
Decisions


Unfair Trade Practices
Price Fixing
Price Discrimination
Predatory Pricing
Luiz Afonso dos Santos Senna - PhD
Unfair Trade Practice Acts
Laws that prohibit
wholesalers and retailers from
selling below cost
Luiz Afonso dos Santos Senna - PhD
Price Fixing
An agreement between two or
more firms on the
price they will charge
for a product (usually in oligopolistic
markets)
Luiz Afonso dos Santos Senna - PhD
Price Discrimination
The Robinson-Patman Act of 1936 (USA):

Prohibits any firm from selling to two or
more different buyers at different prices if
the result would lessen competition
Luiz Afonso dos Santos Senna - PhD
118
Robinson-Patman Act Defenses
Seller Defenses
Cost
Market
Conditions
Competition
Luiz Afonso dos Santos Senna - PhD
Predatory Pricing
The practice of charging a
very low price for a product
with the intent of driving
competitors out of business or
out of a market.
Luiz Afonso dos Santos Senna - PhD
120
Discussion: Impact of Ethics on
Pricing
How should you price if your product is a life-
saving drug?
What are the ethical considerations?
Customers have no choice
Need to pay for the research
When cheaper options doesnt work
Competition decides

Luiz Afonso dos Santos Senna - PhD
Some other pricing strategies
These all involve the use of some numerical
understanding.
Luiz Afonso dos Santos Senna - PhD
Absorption/Full Cost Pricing
Luiz Afonso dos Santos Senna - PhD
Absorption/Full Cost Pricing
Full Cost Pricing attempting to set price to
cover both fixed and variable costs


Absorption Cost Pricing Price set to
absorb some of the fixed costs of production


Luiz Afonso dos Santos Senna - PhD
Marginal Cost Pricing
Luiz Afonso dos Santos Senna - PhD
Marginal Cost Pricing
Marginal cost the cost of producing ONE extra or ONE fewer
item of production
MC pricing allows flexibility
Particularly relevant in transport where fixed costs may be
relatively high

Allows variable pricing structure e.g. on a flight from London to
New York providing the cost of the extra passenger is
covered, the price could be varied a good deal to attract
customers and fill the aircraft
Luiz Afonso dos Santos Senna - PhD
Marginal Cost Pricing
Example:
Aircraft flying from Bristol to Edinburgh Total Cost (including
normal profit) = 15,000 of which 13,000 is fixed cost*
Number of seats = 160, average price = 93.75
MC of each passenger = 2000/160 = 12.50
If flight not full, better to offer passengers chance of flying at
12.50 and fill the seat than not fill it at all!
*All figures are estimates only
Luiz Afonso dos Santos Senna - PhD
Contribution Pricing
Luiz Afonso dos Santos Senna - PhD
Contribution Pricing
Contribution = Selling Price Variable (direct costs)
Prices set to ensure coverage of variable costs and a
contribution to the fixed costs
Similar in principle to marginal cost pricing
Break-even analysis might be useful in such
circumstances
Luiz Afonso dos Santos Senna - PhD
Target Pricing
Luiz Afonso dos Santos Senna - PhD
Target Pricing
Setting price to target a specified profit level
Estimates of the cost and potential revenue at
different prices, and thus the break-even
have to be made, to determine the mark-up
Mark-up = Profit/Cost x 100

This strategy is used by many clothes
retailers where they can add upto 60% mark-
up on the basic cost of the clothes. So even
with a 50% sales offer they still make a profit!
Luiz Afonso dos Santos Senna - PhD
Cost-Plus Pricing
Luiz Afonso dos Santos Senna - PhD
Cost-Plus Pricing
Calculation of the average cost (AC) plus a
mark up

AC = Total Cost/Output
Luiz Afonso dos Santos Senna - PhD
Influence of Elasticity
Luiz Afonso dos Santos Senna - PhD
Influence of Elasticity
Price Inelastic:
% change in Q < % change in P

e.g. a 5% increase in price would be met by a
fall in sales of something less than 5%

Revenue would rise

A 7% reduction in price would lead to a rise in
sales of something less than 7%

Revenue would fall
Luiz Afonso dos Santos Senna - PhD
Influence of Elasticity
Any pricing decision must be mindful of the impact of
price elasticity
The degree of price elasticity impacts on the level of
sales and hence revenue
Elasticity focuses on proportionate (percentage)
changes

PED = % Change in Quantity demanded
% Change in Price
Luiz Afonso dos Santos Senna - PhD
Influence of Elasticity
Price Elastic:
% change in quantity demanded > % change in price

e.g. A 4% rise in price would lead to sales falling by
something more than 4%

Revenue would fall

A 9% fall in price would lead to a rise in sales of
something more than 9%

Revenue would rise
Luiz Afonso dos Santos Senna - PhD
137
Select a Pricing Method
Mark-up Pricing - Cost Plus
Target Return Pricing
Perceived Value Pricing


Luiz Afonso dos Santos Senna - PhD
Device Pricing vs. Whole Product Pricing
Value of any product to its market is strongly
influenced by prices of competitive products
Competitive devices are analyzed, but
products are priced
Product features have different values:
Customer service
Warranties
Distribution channels (e.g., convenience)
The sum of the features makes up the
product
Luiz Afonso dos Santos Senna - PhD
Determining Perceived Value

What value is placed on the end result?
The cost of alternative solutions to the
customer.
A function of:
Prices of comparable (though not identical)
products
The value (+/-) of the products differences vs.
the competitive offering
The value of the Whole Product
Luiz Afonso dos Santos Senna - PhD
Economic Value Analysis
Identify the cost of the competitive product
or process (i.e., the reference value)
Identify all the factors that differentiate the
product.
Determine the value to the customer of
these differentiating factors (i.e., the
differentiation value)
Sum the reference value and the
differentiation value to determine the total
economic value.
Luiz Afonso dos Santos Senna - PhD
Product
Performance
Economic Value

Customers
Perceived
Value
Marketing Effort
*
Pricing Decision
*
A key task of marketing is to translate
the economic value into high
customer perceived value
Economic Value vs. Perceived Value
Luiz Afonso dos Santos Senna - PhD
142
Select a Pricing Method
Mark-up Pricing - Cost Plus
Target Return Pricing
Perceived Value Pricing
Value Pricing
Going Rate Pricing (market price)
Reference Pricing (comparison w/substitutes)
Sealed-Bid Pricing

Luiz Afonso dos Santos Senna - PhD
Select the Final Price
Desired/Required Distributor Margins
Psychological pricing
Influence of other marketing mix elements
Company pricing policies
Impact of price on others
Luiz Afonso dos Santos Senna - PhD
Conjoint Analysis
Stated Preference Methods
Trade-off Analysis
and
Behavioural models
Luiz Afonso dos Santos Senna - PhD
Behavioural Models
-Logit Model-
e= basis of the logarithm neperiano
i- alternative being considered
J= set of alternatives where i is one of them
Ui= utility function of altarnative i
Uj= utility function of alternative j
Luiz Afonso dos Santos Senna - PhD
Ui = utility function
= parameters to be estimated
Xi= attributes
Luiz Afonso dos Santos Senna - PhD
Data Collection
Revealed Preference
Data gained from experience
Good to know about previous experience and
existing products/services
Stated preference
Data gainded from hipothetical questions in
selected scenarios
Good to gain information about new
services/products