Pricing Practices Ver1.3(Dt)

7/31/2019 Pricing Practices Ver1.3(Dt)

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By:Group 4

Abhinav Singh Khanduja (208/2012)Aayush Sharma (209/2012)

Nalini Katiyar (215/2012)Mohit Rathi (220/2012)Kriti Singh (236/2012)Keshav (261/2012)


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Flow Of Presentationo Objective

o Introduction

o Price Discrimination

o Pricing of Multiple Products

o Peak-load Pricing

o Cost-plus Pricing

o Price Skimming

o Transfer Pricing

o Case Study-1: Chicago Symphony Orchestra

o Case Study-2: Pitlochry Film Theatre


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Objective

To understand various concepts of Pricing Practices


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Introduction

Of the decisions made by a manager, none is morecritical to the success of a firm than setting the price ofthe output. The immediate and obvious effect of pricingchoices is reflected in short run profits but prices settoday also can have an important impact on futureprofits. Indeed, pricing decisions frequently are a majorfactor in determining a firms long term success orfailure.


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Price Discrimination Price Discrimination is said to exist when the

same product is sold at different prices to differentbuyers.

For Ex: Popcorns sold at cinema theatres.

Makemytrip.com

Motives To acquire maximum consumer surplus

To gain market share


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Is Any Difference in Price a Sign

of Price Discrimination?? No, only those difference in prices that cannot be

explained by differences in cost.

Ex: Hardcover vs. Paperback

Business Class Travel


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Conditions when Price

Discrimination is Possible Difference in price

elasticities

Market Segmentation

Effective separation ofsub markets

Legal Sanction

Different qualityproducts

Ignorance of buyers


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Segmentation Criteria Geographical Location

Size of purchase order Purchasing power

Time of purchase

Social and Professional Status of buyers

Age of Customers


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Degrees of Price Discrimination First degree: Each separate unit of the output is sold at

a different price to a different buyer

Second degree: Different blocks of goods are chargeddifferently

Third degree: Different price for different group ofconsumers even though the cost of serving is same foreach group


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1st

Degree Price Discrimination


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2nd



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3rd



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Pricing of Multiple Products Almost all the firms today have more than one product in

their line of production Even the most specialized firmsproduce a commodity in multiple models, styles and size.

Each so much differentiated from the other that each modelor size of the product may be considered a different producte.g. the various models of television, refrigerators etc .

Instead of producing a single product at the point whereMR=MC and be left with a great deal of idle capacity, the firm

will introduce new products(or different varieties of existingproducts).

This helps firms to gain large market share on the same ordifferent segments.


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Kinds of Relationships

Demand Relationship. Cost Relationship.

Production Relationship.

Capacity Relationship.

Types of multiple product

Substitute productsJoint products Complementary products Unrelated products


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Pricing of Interrelated Products

Substitute goods are those goods which can be used in placeof each other.

Methods for pricing Substitute Goods:-1. Mark up Pricing:- In this method same margins are used

for all similar products in the line.

2. Varying Margin size:-In this Method as the level of cost

changes margin also vary according to that.


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ContinuedJoint Products:Two or more outputs generated simultaneously, by asingle manufacturing process using a common inputresults in Joint products.

Types of Joint Products :-Fixed proportion case:-In this method two products will beproduced in fixes proportions.

Varying proportion case- In this method there is no fixedlimit and a firm can produces in different proportions. In thiscase total cost should be apportioned to each productbecause a single MC curve no longer suffices.


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Joint Product Pricing: Fixed Proportions Case


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Pricing of Complementary Goods

Goods or services used in conjunction with other goods or services are calledcomplementary goods.

Methods for pricing Complementary Goods:-Loss Leader:-In this method price of a product is set below the customary price

or even at a loss with a view to increase the sale of complementary product.

Tied Sales:-In Tied sales buyers are asked to combine purchases of main product

with complementary products which do not sell well at a low price.

Pricing For Unrelated ProductProducts which are widely different and have no element of interdependenceare called Unrelated products.

Pricing in such case is done separately for each product on basis of their cost

and demand. It is like the single product case.


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Peak-load Pricing

Peak load pricing essentially involves charginghigher prices from consumers wanting to consumeduring the peak demand period and lower price fromthose who consume during off-peak period.

For example - Demand for telephone services is

quite intense during the day time and very low duringthe night time.


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The peakload pricing can be

successfully applied if: The capacity to meet the peak period demand is also

used to meet the consumer demand for the serviceduring the non-peak periods.

The service is non-storable. The demand characteristics vary over time.To reduce pressure of demand during peak period and toinduce consumers to shift to periods of low demand,telephone companies fix higher prices for the peakdemand period and low prices for the low-demandperiod. It can be understood with the help of this

diagram


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For units of capacity Q1 consumer in peak period will pay P1 price

and in off-peak period will pay P2 price, thus making total price for

Q1 units of capacity as P=P1+P2 and total value of capacity as D

=D1+D2. Optimum capacity level is the point Q* where total value of

capacity equals cost of capacity. Here C refers for capacity cost and L

for labour cost. The peak period consumers will have to pay for both C

and L, while off-peak period consumers will pay only L.


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Problems in the application ofpeak-load pricing

It is not easy to have the peak and off-peak demandestimates.

It gives feeling of discrimination so it does not evoke

favourable reaction from public.

It involves flexible prices over time to search for an

optimum combination of prices. It creates serious

administration problems.


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Cost-plus pricing

Cost-plus pricing is used to determine the product price.

The price is determine by adding a fixed mark up to thecost of acquiring or producing the product.

The most popular method of pricing practicing because

a. Simple to compute

b. Assures profitable business

c. Eliminates subjectivity

d. Satisfactory method of taking care of business uncertaintiesand ignorance.

Calculation of cost-plus is done in two steps:

a. Determination of relevant full cost

b. Determination of what plus the firm adopts.


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Continued.

Manufacturing, trading and services sectors calculate costdifferently.

a. In case of manufacturing firms, the standard unit costs are

often calculated on the basis of estimated product demand

and expected input prices.b. In case of trading in goods, the cost of goods is simply the

wholesale price to which transport cost could be added.

Then the mark-up is decided such that it covers up desired

profit and all other costs.

c. In case of service industries(like shops, doctors etc.),

customers are charged in two parts:

i. Charge for labor time,

ii. Charge for material cost.


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Size Of Mark-upThe mark-up should guarantee the seller a fairprofit (also

called net profit margin , NPM).

Desired price (P)=AVC + GPM

AVC + (NPM + AFC)

The NPM is known to the firm from its pastexperience andthis margin is expected to cover the regular investments in thelong run and the risk specific to that product.

The price leader makes his price calculations according to the

average costing rule described above, but does actually chargethe price P which depends upon

Potential competition

General economic environment


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EXAMPLE

A firm produces 5,000 units of commodity X at the total fixed costs of Rs. 20,000

and total variable cost of Rs. 30,000. Find the price which the firm would charge

from its customers if it wants to make a net profit margin of 15% on cost. The

firm uses cost plus pricing method.

Solution: Output of the firm = 5,000 units of commodity X

Total fixed cost (TFC) = Rs. 20,000

Total Variable Cost (TVC) for 5,000 X = Rs. 30,000

Average fixed cost (AFC) = TFC/Units of X = 20,000/5,000 = Rs. 4

Average variable cost (AVC) = TVC/Units of X = 30,000/5,000 = Rs. 6

Average total cost = AFC + AVC = Rs. 4 + Rs. 6 = Rs. 10

Net profit margin (NPM) = 15% of total cost = (15/100)*10 = Rs. 1.50

Price of commodity X (Px) = Rs. 10 + Rs. 1.50 = Rs. 11.50


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Limitation of Cost-Plus Pricing While fixing the marks-up the firm considers its cost but

not the market demand.

It does not adequately take account of the competitionforces.

Since sales of a product depend upon the price charged for

it, it can also be said that the unit cost depend upon the

charged. Thus unit cost cannot provide suitable basis for

fixing price.

This method cannot be applied to industries dealing with

perishable goods.


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Advantages Of Cost-plus

This method is easy and convenient for a firm to adopt, even incases where the firm handles multiple products.

It fulfills the objectives of profit maximisation.

Cost-plus pricing reduces the cost of decision-making. The pricing fixed in this manner are considered fair from the

point of view of consumers.

In practice, firm are uncertain about the demand conditions

facing them. So moving away from the cost-plus price may betoo risky.

Cost-plus pricing is more popular and suitable in industrieswhere price leadership prevails.


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Price Skimming Price skimming is a pricing strategy in which a marketer sets a relatively high

price for a product or service at first, then lowers the price over time.

It is a temporal version of price discrimination/yield management.

In skimming, a company initially sets a relatively high price (well above costs) that

will be acceptable to only a portion of potential customers, namely those who value

the product highly and have the means to buy it.

After the "high end" market is saturated, the price is lowered to attract potential

customers who value the product lower or have lesser means.

A skim strategy clearly exploits the downward sloping demand curve by sequentially

targeting different market segments to maximize initial revenues, and is most

appropriate when time is not of the essence (e.g. competition is not imminent) and

futures-related benefits are minimal.


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The skim price (P2) generates initial sales of Q2, and revenues P2 times Q2 (thesum of squares A and B).

When the price is subsequently reduced to P1, additional sales are generated equalto Q1 minus Q2 (since Q2 sales were made at the higher skim price).

The second round revenues are depicted by box C. So, total revenue under theskim strategy is the sum of the boxes A + B + C.

Assuming that P1 is equal to a penetration price alternative, skimming revenues inthis case exceed initial penetration revenues by an amount represented graphically

as box B.


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The first diagram shows the demand schedule,

price, and quantity demanded at time t=1.

Additional short run demand schedules

representing times t=2 and t=3 are added in

subsequent diagrams.

As time goes by, price decreases and volume

increases.

When the 3 equilibrium are joined we obtain the

price skimmers long run demand schedule (shown

in green).


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EXAMPLE

Apple's iPod. Most iPod consumers are technically sophisticated, and 75% of them areprevious Apple customers.

This consumer base is very likely to contain people who are nearly not price sensitive to

Apple products.

The consequence of the iPod's pricing strategy is to progressively skim off the demand

(starting with the less elastic portion), sacrificing high sales to profit at the beginning.
http://1.bp.blogspot.com/_PgjG093AW58/TOzZzhuvGMI/AAAAAAAAABI/UsZ8mHxZ1Yo/s1600/Apple+-+Ipod+Sales+and+AVP+-+2002-2009.jpg


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Advantages Where a highly innovative product is launched, R&D costs are likely to be high, as are the

costs of introducing the product to the market via promotion, advertising etc. In such cases, the

practice of price-skimming allows for some return on the set-up costs.

By charging high prices initially, a company can build a high-quality image for its product.

Charging initial high prices allows the firm the luxury of reducing them when the threat of

competition arrives. By contrast, a lower initial price would be difficult to increase without

risking the loss of sales volume.

Skimming can be an effective strategy in segmenting the market. A firm can divide the

market into a number of segments and reduce the price at different stages in each, thus

acquiring maximum profit from each segment.

Where a product is distributed via dealers, the practice of price-skimming is very popular,

since high prices for the supplier are translated into high mark-ups for the dealer.

For conspicuous or prestige goods, the practice of price skimming can be particularly

successful, since the buyer tends to be more prestige conscious than price conscious.


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Limitation

It is only effective when the firm is facing an inelastic demand curve. If the long rundemand schedule is elastic ,market equilibrium will be achieved by quantity changesrather than price changes.

Price changes by any one firm will be matched by other firms resulting in a rapidgrowth in industry volume. Dominant market share will typically be obtained by a lowcost producer that pursues a penetration strategy.

Price skimmer must be careful with the law. Price discrimination is illegal in many

jurisdictions, but yield management is not. Price skimming can be considered either aform of price discrimination or a form of yield management. Price discrimination usesmarket characteristics (such as price elasticity) to adjust prices, whereas yieldmanagement uses product characteristics.

The inventory turn rate can be very low for skimmed products. This could causeproblems for your distribution chain. It may be necessary to give retailers highermargins to convince them to enthusiastically handle your product.

Skimming encourages the entry of competitors. When other firms see the high marginsavailable in the industry, they will quickly enter.

Skimming results in a slow rate of diffusion and adaptation. This results in a high levelof untapped demand. This gives competitors time to either imitate the product or leapfrog it with a new innovation.


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Transfer Pricing Transfer Prices are internal prices at which parts and

components from upstream divisions are sold to downstream

divisions in a firm.

Transfer prices need to be chosen correctly as they are signals

that the divisional managers use to determine output levels.

Transfer prices need to be chosen so as to maximize both

divisional as well as firms profit.

Analysis of three scenarios: Transfer pricing with no Outside

Market, Transfer Pricing with a competitive outside market,

Transfer Pricing with a Non-competitive market.


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Transfer Pricing with No External

Market


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Transfer Pricing with Competitive

External Market - Buying


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Transfer Pricing with Competitive

External Market - Selling


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Transfer Pricing with

Noncompetitive External Market


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Case Study 1: Chicago SymphonyOrchestra

Problem: The Chicago Symphony Orchestra hadincreased its average ticket price from $35 to $70 in thedecade from 1990 to 2000. The attendance in 2001/2002dropped from 96-97% in the 1990s to 81%. As a result the

CSO was facing an operating deficit.


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Case Study 1: Chicago Symphony

Orchestra

Analysis: The price elasticity of the same cultural

product varies form one period of time to another. It alsovaries from one customer segment to another. The CSOmaintained a narrow price range and raised prices acrossthe board and as a result did not take advantage of these

differences


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Case Study 1: Chicago Symphony

Orchestra

Solution:

Pricing seat according to place of seat relative to stage

Pricing according to attractiveness of each concert

Pricing according to time and date of the show


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Case Study 2: Pitlochry Festival

TheatreProblem: At the Pitlochry Festival Theatre, drama usedto be the primary genre of their plays. In, 2009 they

introduced a musical Whisky Galore into the mix andit was a resounding success. Based on the success of thismusical they introduced a musical Kiss Me Kate in2010 as well. Their primary problem was how to

maximize revenues from the sales of the musicals ticketswithout negatively affecting the value of the other shows


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TheatreAnalysis: In 2009, the PFT priced the tickets according tothe time of the day, day of week and according to which

of the three price bands the customer sat in theauditorium. Of 540 seats in the auditorium, around 50%

were top-price seats and these were always the first tosell and were usually sold out before customers started

looking for other lower-priced tickets


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TheatreSolution: By increasing the price of a limited no. of seats,which represented an actual difference in value, the

price of over pricing could be minimized. Therefore theprice of around 6% of seats of the top-price band wasincreased. This premium section of seats was madeavailable for all productions. Also, there were across theboard increases in price, based on the success of theprevious season and the price ofKiss Me Kate wasincreased more than the increases in the other playsbased on the success Whisky Galore.


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Documents

Pricing Practices Ver1.3(Dt)