2.17 Pricing

Marketing and the Competitive Environment Using the Marketing Mix:

Pricing

“Price is what you pay. Value is what you get.”

Warren Buffett

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Using the Marketing Mix: PricingIn this topic you will learn about:

Pricing strategies Pricing tactics Influences on pricing decisions

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Pricing strategies

Firms use a number of pricing strategies in order to sell their products. The AQA specification states that you need to know the following:

Price skimming – setting a high initial price for a new product in order to recoup costs

Price penetration – setting a low initial price for a new product in order to get a foothold in the market

Price leaders – where firms that dominate a market with an existing product set the price and other firms in the market follow suit

Price takers – where firms set their prices based on the market price

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Pricing strategies

Price skimmingPrice skimming – setting a high initial price for a new product in order to recoup costs.

When a firm releases a new product it often charges a high price targeting a segment of the market known as ‘early adopters’. These are customers who must have the product as soon as it is launched and are prepared to pay high prices to get it.

Firms often base their initial promotional campaign around this idea, trying to create a ‘must have’ mentality amongst their target market. Once this market has been ‘skimmed off’ the company will lower price.

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Pricing strategies

Price skimming When Sony released PS3 in 2007 the price was a hefty £425.

Why do you think that Sony charged such a high price when they

released the PS3?

What do you think has happened to the price of the PS3 today?

You will need access to the internet to watch this video clip

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Pricing strategies

Price penetration

Price penetration – setting a low initial price for a new product in order to get a foothold in the market.

This is the opposite of price skimming. Here, a firm will release a new product at a low price with the aim of enticing people to buy. The aim is to gain an early customer base.

Once the product has been launched and built up a customer base the firm will raise the price.

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Pricing strategiesPrice Leaders/Price Takers

Price leaders are when firms that dominate a market with an existing product set the price and other firms in the market follow suit.

It is illegal for firms to get together to set prices in order to increase the total value of the market.

Smaller firms will sometimes look to the largest firm in the market to set the price and then follow this price lead. If the smaller firm were to lower their price below that set by the price leader it might start a price war that it has no hope of winning.

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Pricing strategies

Price leaders/Price takers

Price takers are smaller firms in the market who set their prices based on the market price. This might be the price set by the market leader or it might be in a very competitive market where firms sell similar products and customers find it hard to differentiate the product.

If the small firm were to lower price in order to increase market share all other firms would have to follow suit and the customer, rather than the firm, would benefit from lower prices.

A price leader is likely to respond to a smaller firm cutting prices by cutting prices themselves. The small firm would be unlikely to do this because it would retain the same market share but at a lower selling price.

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Pricing tacticsLoss leaders

The selling of products at or below the cost of making the product.

Loss leaders are commonplace in retailing. The idea of a loss leader is to entice the customer into the store in the hope that they will spend money on other, full priced products.

Loss leaders are likely to be heavily advertised so that potential customers are aware of the low price.

When Harry Potter was released stores sold it at such a low price that they didn’t even make a profit:

Why would a firm do this?

You will need access to the internet to watch this video clip

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Pricing tactics

Psychological pricing

Psychological pricing occurs when the firm set a price for the product in order to entice the customer into making a purchase.

A common example of psychological pricing is when a firm charges £9.99 rather than £10.00.

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Pricing strategies and tacticsActivity

Price skimming Price penetration Psychological pricing Loss leaders

Using your own experience try to come up with three different products for each of the above.

State why you think the firm might have used these pricing decisions for each product.

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Influences on Pricing Decisions

Price elasticity of demand (PED)Price elasticity of demand is defined as the responsiveness of demand to a change in price – what will happen to the demand for the product if its price changes.

We can calculate this by using the formula:

PED = % change in Quantity Demanded (Qd) x 100% change in Price (P)

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Price elasticity of demand (PED)It is important to note that the AQA board do not require that candidates have to calculate the PED coefficient. Instead, you will need to know what the figure means. However, understanding the process can benefit candidates understanding of the term.

ExampleA newsagent sells 200 cans of Coca-Cola a week at a price of £0.50. The newsagent raises the price of the Coca-Cola to £0.60 and demand falls to 180 cans. What is the PED for this product?

Firstly, we need to work out the percentage change for demand and price. We use the formula:

Change in value x 100Original value

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Price elasticity of demand (PED)Step 1 Change in Demand x 100 -20 x 100 = - 10%

Original Demand 200

Step 2 Change in Price x 100 10 x 100 = 20%Original Price 50

Step 3 % change in Qd x 100 -10 x 100 = - 0.5% change in P 20

We call the answer the price elasticity of demand coefficient.

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Price elasticity of demand (PED)In the previous slide the final answer was -0.5.

What does a negative figure mean?If the price of a good rises then demand for that good will fall. A rise in price is a positive sign (+) and a fall in demand is a negative sign (-). Therefore, the PED will have a negative figure.

If the price of a good falls then demand for that good will rise. A fall in price is a negative sign (-) and a rise in demand is a positive sign (+). Therefore, the PED will have a negative figure.

The PED for a product will always have a negative figure indicating the inverse relationship between the changing variables. Sometimes however, we ignore the minus sign so that -0.5 becomes 0.5.

Students should realise that -0.5 and 0.5 mean the same thing and therefore denotes the same degree of elasticity i.e. they are both price inelastic.

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Price elasticity of demand (PED)

TYPE OF ELASTICITY

RESPONSE TO A RISE IN PRICE

PED COEFFICIENT CHANGE IN TOTAL REVENUE

INELASTIC Qd changes by a smaller % than P

Between 0 and 1i.e. -0.7 or 0.7

Increases

UNITARY ELASTICITY

Qd changes by the same amount as P

1 Stays the same

ELASTIC Qd changes by a greater % than P

Greater than 1i.e.-1.4 or 1.4

Decreases

The significance of the PED coefficient

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The significance of PEDPrice inelastic – if a product is price inelastic then a firm knows that if it raises Price, even though Demand will fall, Total Revenue will increase.

Price = £1.00 Demand = 100 units PED = - 0.5

What should the firm do? If the firm were to raise price by 10 pence (10%) what would happen to Total Revenue (TR). Using the PED formula:

% change in Qd = - 0.5

10%

- 0.5 x 10% = 5% This is the change in Quantity Demanded, a decrease of 5% from 100 units to 95 units

Therefore the new Total Revenue is:

£1.10 (Price) x 95 (Demand) = £104.50 (Total Revenue)

By raising the price of a price inelastic product the firm has increased TR.

TR will fall if the firm attempts to lower price.

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The significance of PEDPrice elastic – if a product is price elastic then a firm knows that if it lowers Price, Demand will rise and Total Revenue will increase.

Price = £1.00 Demand = 100 units PED = - 2

What should the firm do? If the firm were to lower price by 10 pence (10%) what would happen to Total Revenue (TR). Using the PED formula:

% change in Qd = - 2

10%

- 2 x 10% = 20% This is the change in Quantity Demanded, an increase of 20% from 100 units to 120 units

Therefore the new Total Revenue is:

£0.90 (Price) x 120 units (Demand) = £108.00 (Total Revenue)

By lowering the price of a price elastic product the firm has increased TR.

TR will fall if the firm attempts to raise price.

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The significance of PEDLaptops4u sold 1000 laptops in 2007 at a price of £400 each.

In 2008 they decided to reduce their laptop price to £350. Their price elasticity of demand was -4.

Use the price elasticity of demand formula to work out the new total revenue

Do you think that they were right to lower price?What other factors might have affected the PED over this time period?

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The determinants of PEDA number of factors affect the value of the PED coefficient including:

The availability of substitutes (similar products) – the closer the substitutes the higher the price elasticity

Why do you think that top football clubs can get away with charging such high prices:

The price of competitor goods – if the price of goods in competition with a product increase this will affect demand and price elasticity

Time – the longer the time period the higher the price elasticity. Given more time other firms have the ability to produce similar products and customers have more chance of adapting their buying habits

How have the availability (and price) of substitutes and time affected the PED for wind turbines ?

You will need access to the internet to watch these video clips

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The determinants of PEDA number of factors affect the value of the PED coefficient including:

Branding – firms spend time and money building up their brand image. By creating brand loyalty firms know that their customers will be willing to pay more for the product and they can therefore raise prices.

Income - if consumer incomes are higher then the issue of price becomes less important to the consumer and it is easier for firms to raise price.

You will need access to the internet to watch these video clips

What has happened to price elasticity of demand for

restaurants and theatres (luxury goods) as the

credit crunch hits the UK?

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Problems of measurement of price elasticity

The Price Elasticity of Demand for a product is constantly changing in a dynamic world. It is very difficult for firms to measure because:

• Difficulty in finding accurate information

• Price elasticity changes over different price ranges

• Price elasticity will change over the period of the economic cycle e.g. it will be affected in a recession

• Tastes and fashions are constantly changing

• Competitors don’t stand still. They are continually improving existing products, bringing out new products and trying to promote their products.

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Calculating Total Revenue using Price Elasticity of Demand

Example

A garage sells 100 000 litres of petrol at £1.00 per litre. It has worked out that the PED coefficient for the product is -0.5. The firm is considering raising its price by 10%. Advise the manager whether this is a good decision or not.

Here, we have to work out the % change in Qd

% change in Qd = -0.5

10%

Step 1: Work out the original total revenue

Original total revenue = original total x original price

100 000 x £1.00 = £100 000

Step 2: Work out the % change in Qd

PED x % change in P = % change in Qd

-0.5 x 10 = -5

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Calculating Total Revenue using Price Elasticity of Demand

A garage sells 100 000 litres of petrol at £1.00 per litre. It has worked out that the PED coefficient for the product is -0.5. The firm is considering raising its price by 10%. Advise the manager whether this is a good decision or not.

Step 3: Work out the new total revenue

New sales revenue = new total x new price

Using the figure in Step 2 the new demand has changed by -5%. We know that the price has risen by 10%. Therefore , the new total revenue is:

95 000 litres x £1.10 = £104 500

Based on this information I would advise the manager of the garage to raise the price of petrol.

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Calculating Total Revenue using Price Elasticity of Demand

Bert’s bakeries sell 1 million sausage rolls a year at 50 pence each.

They have estimated that their PED is - 2.5 and Bert is considering lowering price by 5 pence.

Advise Bert on whether or not this would be a good decision. Justify your answer.

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Activity – PED in Britain today

Watch this video of budget shops in Credit Crunch Britain:

The video suggests that budget shops are doing well in the current economic climate.

Why do you think that customers are flocking to budget shops and what does this suggest about the PED of the products that these stores sell?

Discuss the following points when answering this question: The availability of substitutes The price of competitors’ goods Incomes of consumers Branding

You will need access to the internet to watch this video clip.